10-K 1 form10k.htm STANDARD MICROSYSTEMS CORPORATION 10-K 2-29-2012 form10k.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
(Mark
One)
 
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 

For the fiscal year ended February 29, 2012
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) ECURITIES EXCHANGE ACT OF 1934
 
 
For the transition period from to
 
Commission file number: 0-7422
 
STANDARD MICROSYSTEMS CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
 
Delaware
 
11-2234952
(State of Incorporation)
 
(I.R.S. Employer Identification Number)
 
80 Arkay Drive
 
11788-3728
Hauppauge, New York
 
 
(Address of Principal Executive Offices)
 
(Zip Code)
 
(631) 435-6000
(Registrant’s Telephone Number, Including Area Code)
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
Title of Each Class
 
Name of Each Exchange on Which Registered
 
 
Common Stock, $.10 par value
 
The NASDAQ Global Select Market*
 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
 


 
 

 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
 
Aggregate market value of voting stock held by non-affiliates of the registrant as of August 31, 2011, based upon the closing price of the common stock as reported by The NASDAQ Global Select Market* on such date, was approximately $464,459,988.
 
Number of shares of common stock outstanding as of April 17, 2012 22,411,930

DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant’s Proxy Statement for the 2011 Annual Meeting of Shareholders are incorporated by reference into Part II and Part III of this report on Form 10-K.
 
 
 

 

TABLE OF CONTENTS

PART I
 

PART II

 
PART III

Item 10.
 
Directors, Executive Officers and Corporate Governance
 
 
 
 
 
Item 11.
 
Executive Compensation
 
 
 
 
 
Item 12.
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
 
 
 
 
Item 13.
 
Certain Relationships, Related Transactions and Director Independence
 
 
 
 
 
Item 14.
 
Principal Accountant Fees and Services
 
 
 
 
 
42

PART IV

 
PART I
 
Item 1. — Business
 
 
Standard Microsystems Corporation (the “Company” or “SMSC”), a Delaware corporation founded in 1971, is a leading global designer of Smart Mixed-Signal Connectivity™ solutions. Our mission is to create solutions that enable our customers to develop differentiated, content rich systems while generating attractive returns for our shareholders and employees.  Our expertise in analog and mixed-signal processing is applied across a broad set of technologies including Media Oriented Systems Transport (MOST®), wireless audio, USB and Ethernet as well as embedded control, capacitive sensing and thermal management. SMSC’s silicon-based integrated circuits, firmware and systems software are incorporated by a global customer base in end products in the Automotive, Consumer Electronics, Personal Computing (“PC”), and Industrial markets. The Company’s expertise in developing application-specific technologies, each designed to connect, network or monitor systems, allows SMSC to design multi-functional products that address market requirements for on-the-go and embedded consumer and business applications. Most of the Company’s products are unique designs that serve industry leaders across the globe by providing highly integrated solutions that serve their requirements.
 
SMSC’s business is based on substantial intellectual property assets consisting of automotive and computing architecture knowledge, wireless audio and systems capability, high speed interface circuit design, and network engineering expertise.  SMSC’s assets also include patented technology, access to market technology, extensive experience in integrating designs into systems, the ability to work closely with customers to solve technology application challenges and develop products that satisfy market needs, and the ability to efficiently manage its global network of suppliers. These attributes allow SMSC to provide technical performance, cost, size or time-to-market advantages to its customers and to develop leadership positions in several technologies. In addition, SMSC has continued to develop software to promote and distinguish its hardware products. Examples of such software include MOST NetServices to access data transportation mechanisms on a MOST network, the JukeBlox® software platform enabling music streaming to home theater systems, A/V receivers, wireless speakers and portable music player docking stations, and drivers and firmware for USB and computing products, which enable these products to be customized for various applications and operating systems.
 
Over the past several years, SMSC has evolved from an organization having strength primarily in digital design serving a PC centric business to one with broad design expertise in automotive and consumer electronics applications leveraging digital, analog and mixed-signal solutions that cut across all its product lines. Electronic signals fall into one of two categories, analog or digital. Digital signals are used to represent the “ones” and “zeros” of binary arithmetic, and are either on or off. Analog, or linear, signals represent real world phenomena, such as temperature, pressure, sound, speed and motion. These signals can be detected and measured using analog sensors, by generating varying voltages and currents. Mixed-signal products combine digital and analog circuitry into a single device. Mixed-signal solutions can significantly reduce board space by integrating system interfaces, reducing external component requirements and lowering power consumption, all of which reduce system costs. Analog and mixed-signal products are also less susceptible to commoditization because of the custom nature of their designs.
 
SMSC has operations in the United States, Canada, Germany, Bulgaria, India, Japan, Hong Kong, China, Korea, Singapore and Taiwan. Major engineering design centers are located in: Arizona, New York and Texas in the United States; Ottawa, Canada; Chennai and Bangalore, India; Karlsruhe and Pforzheim, Germany; and Sofia, Bulgaria.
 

SMSC’s strategy is to develop innovative, differentiated and content rich connectivity systems that will create value for its customers and distinguish SMSC from its competitors.   SMSC generally seeks to develop feature-rich and high value products while striving to avoid generic and easy to duplicate offerings.  The company is focused on delivering connectivity solutions that enable the proliferation of data in automobiles, consumer devices, personal computers and industrial markets. SMSC’s feature-rich products drive a number of industry standards and include USB, MOST® automotive networking, Kleer® and JukeBlox® wireless audio, and embedded system control and analog solutions, including thermal management and RightTouch® capacitive sensing,

To achieve its strategy, the Company uses a highly integrated approach in the development of its products, and employs discrete technologies which are frequently integrated across many of its products and applications. Further, the Company continuously explores and seeks opportunities to introduce new or existing products, either individually or in combination within systems and end products, for broader application within or across end markets. The Company believes that the integration of products and convergence of applications will be a continuing trend. The Company’s ability to anticipate and capitalize on these trends will be essential to its long-term success, and hence will continue to be a prime strategic consideration in resource allocation decisions and the internal evaluation of the Company’s competitive and financial performance.
 
In executing this strategic approach, internal resources are allocated and corresponding investments are made at the project level in a manner that the Company believes will maximize total returns from product sales both individually (with respect to individual products or product families) and in the aggregate (a “portfolio” approach). Projects consist of either a single product offering (as would be the case for a new product launch) or a product family, consisting of multiple product variants stemming from an original design. Such variants can consist of relatively simple modifications to an original design, introduction of “next generation” capabilities and features and/or strategic integrations of new technologies into existing products. Projects may span across product lines or product families.
 
 
Projected results for each project are evaluated independently for the impact on returns to SMSC as a whole, and the allocation of resources (particularly engineering and R&D investment) are based on the individual project economics. While the Company’s internal resources may be augmented or tempered depending on the business environment, product pipeline and other factors, such decisions are predicated on expected overall project returns and the corresponding impact on consolidated financial performance.
 
We believe that the Company’s expertise in multiple technologies that can be deployed in numerous applications is a competitive advantage that allows us to create differentiated products and a central part of the Company’s strategy. Given the proliferation of customer demand for products based on convergent technologies, especially among the Company’s current product offerings and core competencies, the opportunities available to the Company are expected to increase. In addition, we believe that the continuous focus on such products and opportunities are integral to the future success of the Company.
 
 
SMSC develops its products to serve applications in several end markets including Automotive, Consumer Electronics, PC, and Industrial. Most of the Company’s technologies are sold into multiple end markets, and its product technologies, intellectual property and proprietary processes are increasingly being reapplied and may be combined into new solutions that can be sold into these markets. Its products are manufactured using industry standard processes and all are sold through a unified direct sales force that also manages global relationships with independent, third party sales representatives and distributors.
 
SMSC’s sales and revenues across these end markets, including intellectual property revenues (consisting of royalties and similar contractual payments), are presented in the following table for the twelve months ended February 29, 2012 (“fiscal 2012”) and February 28, 2011(“fiscal 2011”) (in thousands):

   
Fiscal 2012
   
Fiscal 2011
 
   
Amount
   
%
   
Amount
   
%
 
PC
  $ 131,132       31.8 %   $ 151,595       37.0 %
Consumer Electronics
    129,451       31.4 %     110,265       26.9 %
Industrial
    66,924       16.3 %     72,816       17.8 %
Automotive
    84,597       20.5 %     74,803       18.3 %
Total sales and revenues
  $ 412,104       100.0 %   $ 409,479       100.0 %

SMSC’s MOST technology, which enables the networking of information systems in automobiles, such as a CD changer, radio, global positioning system, navigation system, mobile telephone or a DVD player, is the foundation of SMSC’s automotive business. MOST provides the means to distribute multimedia entertainment functions among various control devices in the car.  SMSC sells MOST networking chips of various speeds, and companion chips to allow additional functionality, such as video or power supply, to be delivered via the network. In addition, SMSC has developed TrueAuto™ automotive grade USB and Ethernet products to connect multimedia devices in the car and address a new standard for car diagnostics communication with a repair bay.  SMSC also provides wireless audio technology in the automobile with its Kleer technology.  Finally, SMSC’s K2L subsidiary provides software that supports a wide range of automotive platforms, acting as a gateway for various networks in the car.

SMSC serves the Consumer Electronics market with wireless audio, USB and Ethernet products.  SMSC’s Jukeblox products support the AirPlay® and  DLNA®  standards and allow audio to be streamed wirelessly from devices or the cloud to speakers and docks.  SMSC’s Kleer products deliver high quality audio wirelessly at low cost and power.  Its KleerNet® RF technology enables high quality and low latency wireless distribution of digital content to headphones, speakers and other audio devices to enhance the consumers’ listening experience. USB and Ethernet designs that serve the Consumer Electronics market primarily provide connectivity or networking functions that allow data transfer or content sharing in consumer devices. For instance, the Company provides USB 2.0 hub, flash memory card reader and mass storage devices that may be embedded in LCD monitors, printers, set-top boxes, docking stations, digital televisions or gaming products to transfer content at high speeds. SMSC’s Ethernet networking products address system resource limitations and other challenges typical of embedded consumer electronics systems for applications such as digital televisions, set-top box, DVD and hard disk drive-based video recorders and digital media servers and adapters. SMSC’s portable USB transceiver products are found in tablets, smart phones, personal digital assistants, e-readers and other consumer mobile devices. The Company also designs network multimedia processing engines supporting multiple high definition audio/video streams, and software protocol stack management and security, through Peripheral Component Interconnect (“PCI”) or non-PCI interfaces.

SMSC serves industry leading PC customers in the Mobile & Desktop PC markets with embedded controllers, system controllers, server input/output (“I/O”) devices, USB hubs and analog solutions including capacitive touch and proximity detection, fan control, temperature and voltage sensing and more recently, wireless audio. Applications include mobile and desktop computers, ultrabooks, netbooks, servers and media center PCs.
 
 
SMSC serves the Industrial Market with a portfolio of products to meet the high quality standards and rigorous needs of thousands of customers worldwide.  SMSC has developed Industrial grade products in many product areas and aligns with our suppliers so that we may serve the long life cycle embedded systems of our customers.  SMSC sells Ethernet, ARCnet, CircLink™, USB, Embedded I/O and Analog products into the broad range of industrial end applications which include building and factory automation, industrial robotics, security systems, industrial PCs, video and surveillance systems, motor motion control, and transportation and railway systems.
 
The flexibility of SMSC’s products to address multiple end market applications and the convergence of multimedia technologies is creating new market opportunities. For example, computer makers are supplying devices that address entertainment needs, traditional manufacturers of consumer entertainment goods are addressing computing needs and automotive manufacturers and system integrators are seeking ways to deliver multimedia content or network information systems into the automobile. As a result of substantial investment in research and development (“R&D”) over the past several years, the functionality of SMSC’s products has been greatly enhanced, and SMSC’s portfolio of products  has broadened considerably, enabling increased presence for the Company in many other applications using these technologies. This strategic thrust to link available technologies into new applications and invest in new technologies capable of serving different aspects of these converging markets is expected to result in greater product diversity and broader sales and marketing opportunities.


The Company invests in new product development for Automotive, wireless audio, USB, computing and industrial and networking products.  This structure allows its marketing and engineering teams to focus on end markets, applications, and customer requirements unique to their respective markets and technologies. The technologies used and intellectual property developed within these product development organizations, have significant overlap. The Company strives to repackage and reuse intellectual property across all its product lines. A core engineering function guides the product development teams to a common set of design rules while also contributing analog intellectual property which is used throughout the Company.  This structure allows the Company to develop intellectual property expertise which can be rapidly deployed into diverse markets, accelerating access to new customers.

Automotive
 
SMSC is a supplier of products for the automotive market based on its market-leading MOST technology. MOST is a networking standard which enables the transport of high-bandwidth digital audio, video, packet-based data, and control information. SMSC’s latest generation of MOST products, MOST150, provides greater bandwidth and functionality than its predecessors, MOST25 and MOST50, though these predecessor products continue to be sold into automotive platforms. MOST-enabled network interface controllers (“NICs”) and intelligent network interface controllers (“INICs”) are being designed into automotive networks to transfer high-performance multimedia content among devices such as radios, navigation systems, digital video displays, microphones and CD-players quickly and without electrostatic disruption. The technology is also applicable to new market requirements such as driver assistance.
 
The Company also markets a chip interconnect technology known as Media Local Bus (MediaLB®, or “MediaLB”), enabling consumer applications to easily connect to SMSC’s network interface controllers for MOST. MediaLB is also designed to support future MOST networks, thereby providing a simple migration path from existing MOST architectures to next-generation platforms. The MOST technology is the accepted standard for high bandwidth automotive multimedia networking. Today MOST is adopted in approximately 118 car models on the road worldwide.  The Company also sells related software stacks, system design and diagnostic tool products to customers who need to build or maintain MOST compliant systems.
 
SMSC also provides significant connectivity functions within automobiles via USB, Ethernet and other wireless audio products. SMSC develops and sells USB and Ethernet products built to the exacting quality standards required for automotive applications under the TrueAuto™ brand.  SMSC provides wireless audio products in the car through its Kleer technology.
SMSC’s acquisition of K2L GmbH (“K2L”) in fiscal 2010 has increased SMSC’s automotive-related product offerings. Specifically, the K2L acquisition added software development and systems integration support services for automotive networking applications, including MOST-based systems, among other networks in the car.

Wireless Audio
 
SMSC markets both proprietary and open standards based audio solutions that serve the wireless ecosystem from the cloud to destination.  These products feature high level radio performance and industry-leading low power consumption for the portable, home and automotive markets.   SMSC’s Jukeblox products allow the user to stream audio to numerous devices and serve AirPlay and DLNA enabled devices. Target applications for SMSC’s wireless audio solutions include speakers and docks, home cinema and theater, headphones, home audio networks, TVs, portable media players, ear buds, automotive rear seat entertainment and many others. SMSC has acquired its wireless audio expertise via three acqusitions:  SMSC acquired the assets of Kleer Semiconductor Corporation (“Kleer”) on February 16, 2010;   Wireless Audio IP B.V. (“STS”) on June 14, 2010, and BridgeCo, Inc. on May 19, 2011.
 
 
USB Products

Many of the Company’s connectivity products utilize USB technology, which enables the transfer of data between peripheral devices and hosts.   SMSC’s USB products can be found in PCs, LCD monitors, docking stations, televisions, set-top boxes, smartphones and industrial equipment, among others.

This technology has become the ubiquitous connectivity standard. SMSC is regarded as an industry leader in providing semiconductors that incorporate the current industry USB standard specification, known as USB 2.0 or “Hi-Speed USB”. USB 2.0’s 480 megabit per second data transfer rate supports the high bandwidth and speed requirements of consumer multimedia technologies, and because of its ease-of-use and the capability to deliver regulated power, is currently the leading standard by which interoperability and connectivity is provided between diverse systems platforms such as consumer electronics, multimedia computing and mobile storage applications. Designers are attracted to USB 2.0’s speed, “plug-and-play” features and its predictable software development requirements. The ubiquity of USB 2.0 integrated circuits and software makes it a cost-effective choice for designers to add a high-speed serial data pipe for transferring media content.
 
SMSC has developed products to support the next generation USB technology, known as USB 3.0 or “SuperSpeed USB”. USB 3.0 provides data transfer rates approximately 10 times faster than Hi-Speed USB, up to 5 Gbps, and is well suited for applications using video and large data files, such as those found in enterprise commercial applications as well as consumer multimedia solutions. SMSC is developing USB 3.0 products that can be used in platforms such as digital TVs, LCD monitors, printers, PCs, gaming consoles, digital video cameras, smartphones and other embedded and consumer applications.

SMSC also employs USB in portable products for consumer electronic applications.  SMSC’s portable products are designed for set-top boxes, smart phones, personal digital assistants and other handheld mobile devices. These products include standalone USB 2.0 physical layer transceivers (“PHY”) supporting industry standard interfaces as well as USB 2.0 flash memory card readers. These products also include USB PHYs integrated with other functions such as battery management and voltage protection. These Hi-Speed USB transceivers currently set new standards for integration, low power and small size, helping designers meet the tight board space and cost requirements of portable products.

Important USB products include among others:

 
·
USB 3.0 ViewSpan™ Graphics Controller and USB 3.0 Hub,
 
·
USB 2.0 ViewSpan™ Graphics Controller, USB 2.0 -port, 3-port, 4-port, 7-port hub controllers and combination hub/flash memory card reader products,
 
·
USB 2.0 flash memory card reader products, including controllers supporting Secure Digital™ (SD), MultiMediaCard™  (MMC), Memory Stick® (MS), MS-PRO-HG™, SmartMedia® (SM), xD-Picture Card TM (xD) and Compact Flash(R) (CF) memory and Compact Flash-UDMA card families, and
 
·
USB-to-Ethernet hub combo controllers allowing developers to deliver Ethernet connectivity while leveraging the proliferation of USB.

Computing Products

SMSC’s technology expertise also extends into the x86-based notebook, desktop and server segments of the PC market. The Company’s embedded controller solutions offer programmable, mixed-signal features that allow feature-customization for notebook and desktop PCs. Its advanced I/O products for server applications build on SMSC’s broad I/O and system management expertise and include timers, flash memory interfaces, and other server requirements. SMSC also offers a set of chips that offer additional system features such as general purpose input/output (“GPIO”) expansion, temperature and voltage sensing, fan control and consumer infrared remote control. One of the growth opportunities for SMSC is in serving the tablet market where the Company is developing products that are platform-independent and can serve both x86 and non-x86 processor-based designs.
 
SMSC is also developing analog products that utilize thermal sensor technology to target computing and consumer solutions supplied by major OEMs, ODMs and motherboard manufacturers. Also included are capacitive touch and proximity detection, USB battery charging, temperature sensing and fan control products. Many of SMSC’s customers increasingly seek analog functionality such as thermal management, capacitive sensing and battery charging as part of their broader PC buying decision, which, in many cases, calls for an integrated solution. SMSC’s analog products serve computing, consumer and industrial applications.
 
SMSC differentiates its products by combining industry-standard interfaces with advanced application-specific platform solutions. Most of the devices sold into this set of customers and markets must integrate seamlessly with microprocessors and chipsets developed by other companies. SMSC’s solutions optimize the customer’s platform designs and typically improve time-to-market while reducing the total bill of materials cost. These products can be found in notebook and desktop PCs.

 
Important SMSC computing products are:
 
 
·
Embedded controllers for Original Equipment Manufacturer (“OEM”) and Original Design Manufacturer (“ODM”) PC designers,
 
·
Advanced I/O controllers,
 
·
Analog capacitive and proximity detection products,
 
·
USB battery charging controllers,
 
·
Analog thermal management solutions,
 
·
Consumer infrared and system diagnostics companion devices, and
 
·
X86-based server solutions offering timers, flash memory interfaces and thermal management capabilities.

Industrial and Networking Products

SMSC’s industrial products utilize Ethernet, USB, ARCnet, CircLink™, Embedded I/O, Analog and other technologies. Ethernet is widely recognized as a ubiquitous, versatile networking technology for home, business and industrial environments. In its many years of designing networking products, SMSC has shipped more than 100 million Ethernet ports.  SMSC’s strength in this area is the delivery of rich software driver libraries which enable a broad range of industrial operating system support.  A primary focus of the Company’s efforts in this area is developing products that connect USB and Ethernet, such as USB-to-Ethernet controllers and USB hubs with integrated Ethernet controllers. The prevalence and speed of USB has resulted in the USB-to-Ethernet connection often replacing older means of transferring information, such as legacy bus and Peripheral Component Interconnect, referred to as PCI interfaces.  SMSC also serves the industrial market with other networking technologies, such as Attached Resource Computer Network, referred to as ARCNET and CircLink™, an ARCNET derivative.

Important industrial and networking products include:

 
·
USB to Fast Ethernet and USB to Gigabit Ethernet Controllers,
 
·
Low-power and small form-factor Fast Ethernet Transceivers,
 
·
Industrial temperature supported Gigabit Ethernet Transceivers,
 
·
PCI and Local  bus interface Fast Ethernet Controllers, and
 
·
ARCnet and CircLink™ products for wireless base stations, copiers, building automation, robotics, gaming machines and industrial applications.
 
The Company’s primary sales and marketing strategy is to achieve design wins (selection of the Company’s product for use in a specific device or platform) with technology leaders and channel customers in targeted markets by providing superior products, field applications and engineering support. Sales managers are dedicated to key OEM and ODM customers to achieve high levels of customer service and to promote close collaboration and communication. Supporting the success of its customers through technological excellence, innovation and overall product quality are centerpieces of SMSC’s corporate sales and marketing strategy.
 
The Company also serves its customers with a worldwide network of field application engineers. These engineers assist customers in the selection and proper use of its products and are available to answer customer questions and resolve technical issues. The field application engineers are supported by factory application engineers, who work with the Company’s factory design and product engineers to develop the requisite support tools and facilitate the introduction of new products.
 
The Company strives to make the “design-in” of its products as easy as possible for its customers. To facilitate this, SMSC offers a wide variety of support tools, including evaluation boards, sample firmware diagnostics programs, sample schematics and printed circuit board layout files, driver programs, data sheets, industry standard specifications and other documentation. These tools are readily available from the Company’s sales offices and sales representatives. SMSC’s home page on the World Wide Web ( www.smsc.com ) provides customers with immediate access to its latest product information. In addition, the Company maintains online tool resources so that registered customers can download these items as needed. Customers are also provided with reference platform designs for many of the Company’s products, which enable easier and faster transitions from initial prototype designs through final production releases.
 
SMSC strategically markets and sells all of its products globally through a centrally managed sales network using various channels in multiple geographic regions. SMSC conducts sales activities in the United States via a direct sales force, electronics distributors and manufacturers’ representatives. Internationally, products are marketed and sold through its Japanese subsidiary, SMSC Japan, and regional sales offices located in Germany, Hong Kong, Taiwan, China, Korea and Singapore as well as through a network of independent distributors and representatives.

Consistent with industry practice, most distributors have certain rights of return and price protection privileges on unsold products. Accordingly recognition of revenue and associated gross profit on shipments to a majority of the Company's distributors is deferred until the distributors resell the products. Distributor contracts may generally be terminated by written notice by either party. The contracts specify the terms for the return of inventories. Shipments made by SMSC Japan to its distribution partners are made under agreements that permit limited stock return and no price protection privileges, therefore, the sales and associated gross profit from shipments to the Company’s distributors in Japan, are recognized upon shipment.
 
 
The Company generates a significant portion of its sales and revenues from international customers. While the demand for the Company’s products is driven heavily by the worldwide demand of U.S.-based OEM computer manufacturers, a significant portion of the Company’s products are sold to manufacturing subcontractors of those U.S.-based companies, and to distributors who feed the high technology manufacturing pipeline in Asia. The Company expects that international shipments, particularly to Asian-based customers and European based automotive customers, will continue to represent a significant portion of its sales and revenues. See Part I Item 1.A. — Risk Factors — Business Concentration in Asia for further discussion.

 
The information below summarizes sales and revenues to unaffiliated customers for fiscal 2012, 2011, and 2010 by country (in thousands):

For the Fiscal Years Ended February 29 and 28,
 
2012
   
2011
   
2010
 
China
  $ 85,787     $ 77,247     $ 67,287  
Taiwan
    74,988       88,343       75,548  
Japan
    68,319       73,588       47,055  
United States
    30,474       33,853       21,665  
Germany
    27,616       28,197       20,852  
Hong Kong
    27,289       22,569       16,423  
Other
    97,631       85,682       58,948  
    $ 412,104     $ 409,479     $ 307,778  

Product sales to electronic component distributors were reflected in the table above based on the country of their respective operations; the geographic locations of end customers may differ. The majority of SMSC’s sales are to customers located in Asia given Asia’s prominence in the global supply chain for computing, consumer electronics and related applications.
 
The Company’s net property, plant and equipment by country is as follows (in thousands):
 
As of February 29 and 28,
 
2012
   
2011
 
United States and Canada
  $ 49,206     $ 58,601  
Luxembourg
    7,398       -  
Taiwan
    2,922       3,393  
Other Asia Pacific
    3,379       3,235  
Germany and Other Europe
    1,518       2,153  
    $ 64,423     $ 67,382  

 
The Company’s business is characterized by short-term order and shipment schedules, rather than long-term volume purchase contracts. The Company generally schedules production, which typically takes several months based upon a forecast of demand for its products, recognizing that subcontract manufacturers require long lead times to manufacture and deliver the Company’s final products. The Company modifies and rebalances its production schedules to actual demand as required. Typical of industry practice, orders placed with the Company may be canceled or rescheduled by the customer on short notice without significant penalty. Such cancellations usually occur within our lead time. In addition, incoming orders and resulting backlog can fluctuate considerably during periods of perceived or actual semiconductor supply shortages or overages. As a result, the Company’s backlog may not be a reliable indicator of future sales and can fluctuate considerably.
 
The Company had one customer that accounted for sales and revenues in excess of 10% of the Company’s total sales and revenues in fiscal 2012, 2011, and 2010, who is listed below:
 
For Fiscal Years Ended February 29 and 28,
 
2012
   
2011
   
2010
 
Avnet Asia
    12 %     16 %     12 %

The Company’s contracting sales party may vary as a result of the manner in which it goes to market, the structure of the semiconductor market, industry consolidation and customer preferences. In many cases the Company’s products will be designed into an end product by an OEM customer who will then contract to have the product manufactured by an ODM. In such cases, the Company will sell its products directly to the selected ODM, who becomes the Company’s contracting party for the sale. In other cases, the OEM or ODM may design the product and be the contracting party. In some cases the Company or the ODM may wish to have a distributor as the direct sales party. As a result of changing relationships and shifting market practices and preferences, the mix of customers can change from period to period and over time. See Part I Item 1.A. — Risk Factors — Strategic Relationships with Customers for further discussion.
 
 
The Company’s financial results have been significantly dependent on multiple United States-based computer manufacturers that drive a significant portion of the ultimate demand for the Company’s products. In addition, consumer and computing customers in Asia are becoming an increasingly significant source of demand for the Company, as well as European automotive customers.

 
SMSC has what is commonly referred to as a “fabless” production and manufacturing model, meaning that the Company does not own the manufacturing assets to manufacture, assemble and test the silicon wafer-based integrated circuits. Third party contract foundries, package assemblers and test service providers are engaged to fabricate the Company’s products onto silicon wafers, cut these wafers into die, assemble the die into finished packages and test the devices. This strategy allows the Company to focus its resources on product design and development, marketing, test and quality assurance. It also reduces fixed costs and capital requirements and provides the Company access to some of the most advanced manufacturing capabilities.  See Part I Item I.A. — Risk Factors — Reliance upon Subcontract Manufacturing , for further discussion. The Company also faces certain risks as a result of doing business in Asia, where many of the Company’s subcontractors conduct business. See Part I Item I.A. — Risk Factors — Business Concentration in Asia , for further discussion.
 
The Company’s primary wafer suppliers are currently:

 
·
GLOBALFOUNDRIES Inc.
 
·
Taiwan Semiconductor Manufacturing Company Limited (“TSMC”)
 
·
Grace Semiconductor Manufacturing Corporation

The Company may negotiate additional foundry supply contracts and establish other sources of wafer supply for its products as such arrangements become useful or necessary, either economically or technologically.
 
Processed silicon wafers are shipped to various third party assembly suppliers, most of which are located in Asia, where they are separated into individual chips that are then packaged. This enables the Company to take advantage of these subcontractors’ cost effective high volume manufacturing processes and package technologies, speed and supply flexibility.
 
The Company purchases most of its assembly services from the following:

 
·
Advanced Semiconductor Engineering, Inc.
 
·
Amkor Technology, Inc.
 
·
ChipMOS TECHNOLOGIES LTD.
 
·
Orient Semiconductor Electronics Ltd.
 
·
STATS ChipPAC Ltd.

The Company also employs a third party turnkey contract manufacturer, Accent International S.A. (“Accent”), for its wireless audio Jukeblox products.   As a turnkey manufacturer, Accent coordinates and is responsible for the procurement of wafers, assembly and test.

Following assembly, each of the packaged units receives final testing, marking and inspection prior to shipment to customers. During fiscal 2010, the Company relocated the majority of its test floor activities from Hauppauge, New York to a third party facility (Sigurd Microelectronics Corporation) in Taiwan. This third party test house is now responsible for testing the majority of the Company's parts. Final testing services of independent test suppliers, most of which occurs in Asia, are also utilized and afford the Company increasing flexibility to adjust to near-term fluctuations in product demand and corresponding production requirements.
 
Customers demand semiconductors of the highest quality and reliability for incorporation into their products. SMSC focuses on product reliability from the initial stages of the design cycle through each specific design process, including production test design. In addition, to further validate product performance across process variation and to ensure acceptable design margins, designs are typically subject to in-depth circuit simulation at temperature, voltage and processing extremes before initiating the manufacturing process. The Company prequalifies each of its assembly, test and wafer foundry subcontractors using a series of industry standard environmental product stress tests, as well as an audit and analysis of the subcontractor’s quality system and manufacturing capability. Wafer foundry production, assembly and test services are monitored to produce consistent overall quality, reliability and yield levels.
 
 
As a fabless semiconductor company, SMSC does not directly purchase commodities used in the manufacturing process. However, the Company may be subject to commodity price risk as detailed in Part I — Item 1.A. — Risk Factors — Reliance Upon Subcontract Manufacturing and in Part II — Item 7.A — Quantitative and Qualitative Disclosures About Market Risk — Commodity Price Risk.
 
 
The semiconductor industry and the individual markets that the Company currently serves are highly competitive, and the Company believes that continued investment in R&D is essential to maintaining and improving its competitive position.
 
SMSC’s R&D activities are performed by highly-skilled engineers and technicians, and are primarily directed towards the design of integrated circuits in both mainstream and emerging technologies, the development of software drivers, firmware and design tools and intellectual property (“IP”), as well as ongoing cost reductions and performance improvements in existing products. SMSC employs engineers with a wide range of experience in software, digital, mixed-signal and analog circuit design, from experienced industry veterans to new engineers recently graduated from universities. SMSC had approximately 548 engineers as of February 29, 2012. High tech hardware, software and other product design tools procured from leading global suppliers support their activities. The Company’s major engineering design centers are strategically located in: Arizona, New York and Texas in the United States; Ottawa, Canada; Singapore; Chennai and Bangalore, India; Karlsruhe and Pforzheim, Germany; and Sofia, Bulgaria to take full advantage of the technological expertise found in each region, and to cater to its customer base.
 
The Company intends to continue its efforts to develop innovative new products and technologies, and believes that an ongoing commitment to R&D is essential in order to maintain product leadership and compete effectively. Therefore, the Company expects to continue to make significant R&D investments in the future. Acquisitions of  BridgeCo, Inc., Tallika Corporation, K2L, Kleer, STS, Symwave, and the formation of a design center in Sofia, Bulgaria have added additional engineering talent and capabilities.
 
The Company spent the following on R&D (in thousands):

For Fiscal Years Ended February 29 and 28,
 
2012
   
2011
   
2010
 
R&D Spending
  $ 100,350     $ 96,370     $ 77,702  

Intellectual Property

The Company believes that intellectual property is a valuable asset that has been, and will continue to be, important to the Company’s success. The Company has received numerous United States and foreign patents, or cross licenses to patents that relate to its technologies and additional patent applications are pending. The Company also has obtained certain domestic and international trademark registrations for its products and maintains certain details about its processes, products and strategies as trade secrets. It is the Company’s policy to protect these assets through reasonable means. To protect these assets, the Company relies upon nondisclosure agreements, contractual provisions, patent, trademark, trade secret and copyright laws.
 
SMSC has patent cross-licensing agreements with certain semiconductor manufacturers such as Intel Corporation, Micron Technology, National Semiconductor Corporation and Samsung Electronics Co. providing access to approximately 30,000 U.S. patents. Almost all of the Company’s cross-licensing agreements give SMSC the right to use patented intellectual property of the other companies royalty-free. In situations where the Company needs to acquire strategic intellectual property not covered by cross-licenses, the Company at times will seek to, and has entered into agreements to purchase or license, the required intellectual property.
 

BridgeCo
 
On May 19, 2011 SMSC completed the acquisition of BridgeCo, Inc. (“BridgeCo”), a leader in wireless networked audio technologies. BridgeCo's JukeBlox® technology connects tablets, smartphones, PCs, Macs and other consumer electronics products by enabling consumers to access their local or cloud-based music library from any device and from any room in the home. Its JukeBlox software platform, with integrated WiFi® support, enables music streaming to virtually all home audio equipment including home theater systems, A/V receivers, radios, wireless speakers and portable music player docking stations. BridgeCo's technology has been adopted by some of the largest consumer electronics brands in the world including Pioneer, Philips, Denon, Marantz, JBL, B&W and Harmon/Kardon.
 
The majority of BridgeCo’s assets were located in the United States. BridgeCo also had operations in India and Japan. The functional currency of BridgeCo’s operations in India is the Indian Rupee and in Japan, the Japanese Yen.
 
SMSC made an initial investment of $41.0 million in cash (net of cash acquired). The terms of the purchase agreement provide for potential earnout payments of up to $5.0 million in 2012 and up to $22.5 million in 2013 to former BridgeCo shareholders, dependent on BridgeCo reaching certain revenue goals in calendar years 2011 and 2012.  The former BridgeCo business earned the first earnout and SMSC paid the former BridgeCo shareholders $5.0 million in the fourth quarter of fiscal year 2012.
 
In addition, an employee incentive bonus plan was established as part of the merger agreement in which a portion of the earnout payment due to shareholders was apportioned to employees contingent upon continuous future employment as of the specified payout dates established by the plan. This portion of the earnout was not included as part of the contingent consideration liability but is being charged to earnings over the required service period as earned.
 
 
The fair value of the contingent consideration at acquisition of $8.8 million was estimated by applying the income approach. That measure is based on significant inputs that are unobservable in the market, and are therefore level 3 inputs. Key assumptions include a discount rate of 19 percent and a probability-adjusted level of forecasted quarterly revenues.
 
Symwave
 
On November 12, 2010 SMSC completed the acquisition of Symwave, Inc. (“Symwave”), a global fabless semiconductor company supplying high-performance analog/mixed-signal connectivity and USB 3.0 solutions utilizing proprietary technology, leading edge IP and silicon design capabilities. SMSC made an initial $5.2 million equity investment in Symwave in fiscal 2010, resulting in an equity stake of approximately 14 percent, and in fiscal 2011 provided $3.1 million in bridge financing to Symwave. At acquisition, the initial equity investment was revalued to $2.0 million and an impairment loss of $3.2 million was recorded within income from operations.
 
During the fourth quarter of fiscal 2011 the Company lost its primary customer in its storage solutions business. As a result, the Company initiated a plan to reduce costs and investments in this business. In connection with this action, the Company incurred an impairment loss of $3.5 million, primarily for certain indefinite-lived purchased technologies acquired as part of this business. However, the Company is continuing to utilize Symwave USB 3.0 intellectual property and has retained key engineering talent.
 
STS
 
On June 14, 2010 SMSC acquired Wireless Audio IP B.V. ("STS"), a fabless designer of plug-and-play wireless solutions for consumer audio streaming applications, including home theater, headphones, LED TVs, PCs, gaming and automotive entertainment. Customers include many of the industry's leading consumer and PC brands.
 
Kleer
 
On February 16, 2010 SMSC acquired substantially all the assets and certain liabilities of Kleer Corporation and Kleer Semiconductor Corporation (collectively “Kleer”), a designer of high quality, interoperable wireless audio technology addressing headphones and earphones, home audio/theater systems and speakers, portable audio/media players and automotive sound systems.
 
K2L
 
On November 5, 2009, the Company (through its wholly-owned subsidiary, SMSC Europe GmbH) completed the acquisition of 100 percent of the outstanding shares of K2L GmbH (“K2L”), a privately held company located in Pforzheim, Germany that specializes in software development and systems integration support services for automotive networking applications, including MOST®-based systems.
 
Tallika
 
On September 8, 2009, the Company completed its acquisition of certain assets of Tallika Corporation and 100 percent of the outstanding shares of Tallika Technologies Private Limited (collectively, “Tallika”), a business with a team of approximately 50 highly skilled engineers operating from design centers in Phoenix, Arizona and Chennai, India, respectively.
 
EqcoLogic
 
On November 23, 2010, SMSC invested $2.0 million in EqcoLogic, N.V. (“EqcoLogic”), a Belgian corporation based in Brussels, Belgium. EqcoLogic is a developmental-stage company in the field of high speed and bidirectional data transmission. SMSC holds approximately 18.0 percent of the total outstanding equity of EqcoLogic on a fully diluted basis.
 
Canesta
 
During fiscal 2010, SMSC invested $2.0 million in Canesta, a privately held developer of three-dimensional motion sensing systems and devices. Canesta entered into an Asset Purchase Agreement with Microsoft, pursuant to which Microsoft acquired substantially all of the assets of Canesta. On November 30, 2010, SMSC received $2.2 million in cash from Canesta and another $0.1 million on January 27, 2011 pursuant to its Asset Purchase Agreement with Microsoft (approximately $0.7 million in additional distributions will be held in escrow for 12 months or until all of the obligations of Canesta have been satisfied). As a result, the Company recorded a gain of $0.3 million.
 
At February 29, 2012, the Company employed 1,064 individuals, including 558 in research and product development, 204 in sales, marketing and customer support, 161 in manufacturing and manufacturing support, and 141 in administrative support and facility maintenance activities.
 
 
The Company’s future success depends in large part on the continued service of key technical and management personnel and its ability to continue to attract and retain qualified employees, particularly highly skilled design, product and test engineers involved in manufacturing existing products and the development of new products. The competition for such personnel is often intense.
 
The Company has never had a work stoppage. None of SMSC’s employees are represented by labor organizations, and the Company considers its employee relations to be positive.

 
The Company competes in the semiconductor industry, servicing and providing solutions for various applications. Many of the Company’s larger customers conduct business in the PC and related peripheral devices markets. Intense competition, rapid technological change, cyclical market patterns, price erosion and periods of mismatched supply and demand have historically characterized these industries. See Part I Item
1.A. — Risk Factors, for a more detailed discussion of these market characteristics and associated risks.
 
The principal methods employed by the Company to compete effectively include introducing innovative new products, providing superior product quality and customer service, adding new features to its products, improving product performance, providing time-to-market advantages and reducing manufacturing costs. SMSC also cultivates strategic relationships with certain key customers who are technology leaders in its target markets, and who provide insight into market trends and opportunities for the Company to better support those customers’ current and future needs. A substantial amount of the Company’s revenues come from products that are single sourced by its customers, either because of the proprietary nature of the Company’s product offerings or because of the inability of competitors to reproduce the features contained in the Company’s products.
 
The Company’s principal competitors across its various product lines include the following:

 
·
ASIX Electronics Corp
 
·
Avnera Corporation
 
·
Broadcom Corporation
 
·
Cypress Semiconductor Corporation
 
·
Davicom Semiconductor, Inc.
 
·
ENE Technology Inc.
 
·
Genesys Logic, Inc.
 
·
GMT, Inc.,
 
·
Integrated Technology Express, Inc.
 
·
Marvell Technology Group Ltd.
 
·
Micrel Inc.
 
·
Nuvoton Technology Corporation
 
·
Realtek Semiconductor Corp.
 
·
Renesas Electronics Corporation
 
·
ST-Ericsson
 
·
Syncomm Technology Corporation
 
·
Texas Instruments Inc.
 
As SMSC continues to broaden its product offerings, it will likely face new competitors. Many of the Company’s current and potential competitors have greater financial resources and the ability to invest larger dollar amounts into research and development. Some have their own manufacturing facilities, which may give them a cost advantage on large volume products and increased certainty of supply.
 
The Company believes that it currently competes effectively in the areas discussed above to the extent they are within its control. However, given the pace at which change occurs in the semiconductor, PC, automotive and other high-technology industries, SMSC’s current competitive capabilities are not a guarantee of future success. In addition, reductions in the growth rates of these industries, or other competitive developments, could adversely affect its future financial position, results of operations and cash flows.
 
 
The Company’s business historically has been subject to repeated seasonality, with the first and last quarters of each fiscal year tending to be weaker than the second and third. However, SMSC’s typical seasonality can be altered materially by market conditions. See Part I Item 1.A. — Risk Factors — Worldwide Economic Conditions; Seasonality of the Business, for further discussion.
 
 
 
SMSC’s website address is www.smsc.com. Through the Investor Relations section of our website we make available, free of charge, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 (the “Exchange Act”), as well as any filings made pursuant to Section 16 of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (the “SEC”). Our Internet website and the information contained therein or incorporated therein are not incorporated into this Annual Report on Form 10-K.
 
You may also read and copy materials that we have filed with the SEC at its Public Reference Room located at 450 Fifth Street, N.E., Washington, D.C. 20549. Please call the Commission at 1-800-SEC-0330 for further information on the Public Reference Room. In addition, the Commission maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically at www.sec.gov.
 
 
Readers of this Annual Report on Form 10-K (“Report”) should carefully consider the risks described below, in addition to the other information contained in this Report and in the Company’s other reports filed or furnished with the SEC, including the Company’s prior and subsequent reports on Forms 10-Q and 8-K, in connection with any evaluation of the Company’s financial position, results of operations and cash flows.
 
The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties not presently known or those that are currently deemed immaterial may also affect the Company’s operations. Any of the risks, uncertainties, events or circumstances described below could cause the Company’s financial condition or results of operations to be adversely affected.

WORLDWIDE ECONOMIC AND POLITICAL CONDITIONS AFFECT THE COMPANY’S RESULTS
 
Worldwide Economic Conditions — The global political and economic situations continue to be extremely volatile. Economic activity appeared to decrease significantly during the second half of calendar year 2011 and concern for a potential double dip recession appeared to be widespread.  The European sovereign debt crisis, economic problems in Greece, Iran’s nuclear program, and governmental changes in Arab countries have all contributed to significant economic and political instability. Although economic activity appeared to have stabilized in the beginning of calendar year 2012, the Company’s revenue and profitability will be affected if global economic conditions do not, at a minimum, continue at their current levels.  The above political and economic situations or other factors could result in a decline in worldwide economic conditions, which could adversely affect the Company. The Company’s results may also be adversely affected if economic conditions prevent the Company from executing on its strategy to produce more revenue and profit in fiscal year 2013 and later years.

The impact of past decline in global economic activity includes the ongoing failure of the auction rate securities market. As a result of the market conditions affecting auction rate securities, the Company reclassified its investments in auction rate securities from short-term to long-term, and has taken temporary impairments to their value on its balance sheet. If the issuers of the Company’s auction rate securities suffer a material decline in their creditworthiness, or if market conditions for auction rate securities do not recover sufficiently, the value of the Company’s auction rate securities could be other than temporarily impaired, which would affect the Company’s profit and loss statement for the relevant period. Further, the Company may be required to recognize additional temporary impairments in future periods.
 
THE COMPANY OPERATES IN A HIGHLY COMPETITIVE INDUSTRY AND RELATED MARKETS; AND HAS EXPERIENCED SIGNIFICANT VOLATILITY IN ITS STOCK PRICE
 
The Semiconductor Industry  — The Company competes in the semiconductor industry, which has historically been characterized by intense competition, rapid technological change, cyclical market patterns, price erosion, periods of mismatched supply and demand and high volatility of results. The semiconductor industry has experienced significant economic downturns at various times in the past, characterized by diminished product demand and accelerated erosion of selling prices. In addition, many of the Company’s competitors in the semiconductor industry are larger and have significantly greater financial and other resources than the Company. General conditions in the semiconductor industry, and actions of specific competitors, could adversely affect the Company’s results. Declining sales and demand could result in aggressive pricing from competitors to maintain market share, which the Company might have to match to maintain its customer base. Such actions could result in decreases in the Company’s selling prices, which could materially affect its revenues and profitability.
 
The semiconductor industry, including its supply chain, is maturing, and has been undergoing consolidation through mergers and acquisitions. As a result of these factors the Company may experience changes in its relationships in the supply chain and may have fewer sources of supply for wafer production, assembly services, or other products or services it needs to procure.  This could impair sourcing flexibility or increase costs. The Company may also face fewer and larger, more capable competitors. Consolidation and ownership changes within the semiconductor industry could adversely affect the Company’s results.
 
The Personal Computer (“PC”) Industry — Demand for many of the Company’s products depends largely on sales of personal computers and peripheral devices. The growth of tablets has dramatically reduced estimates of potential growth rates for personal computers. Decreases or reductions in the rate of growth of the PC market, due to tablets or worldwide economic and political conditions, could adversely affect the Company’s operating results. In addition, as a component supplier to PC manufacturers, the Company may experience greater demand fluctuation than its customers themselves experience.
 
 
The PC industry is characterized by ongoing product changes and improvements, such as the emergence of tablet PCs, much of which is driven by several large companies whose own business strategies play significant roles in determining PC architectures. Future shifts in PC architectures may not always be anticipated or be consistent with the Company’s product design “roadmaps”.
 
The Company has a business strategy that involves marketing and selling new products and technologies directly to market-leading companies (although resultant sales are often made to third-party intermediaries such as ODMs). The Company’s results are also heavily dependent on demand driven by North American computer makers to whom the Company markets directly. If the market performance of any of these companies declines materially, as occurred during fiscal year 2011 and 2010, or if they require fewer products from the Company than forecasted, the Company’s revenues and profitability could be adversely affected.

These large companies also possess significant leverage in negotiating the terms and conditions of supply as a result of their market power. The Company may be forced in certain circumstances to accept potential liability for intellectual property, quality, delivery or other issues far exceeding the purchase price of the products sold by the Company, the lifetime revenues received from such products by the Company, or various forms of potential consequential damages to avoid losing business to competitors. More large companies have made such requests recently, and the Company is seeing more of these requests as it attempts to expand its business. The Company attempts to negotiate liability caps but is not always successful. The Company may be forced to agree to uncapped liability for such items as intellectual property infringement or confidentiality in order to win important designs, maintain existing business, or be permitted to bid on new business. Such terms and conditions could adversely impact the financial viability of the Company, and its revenues and margins.
 
Volatility of Stock Price  — The volatility of the semiconductor industry has also been reflected historically in the market price of the Company’s common stock. The market price of the Company’s common stock may fluctuate significantly on the basis of such factors as the Company’s or its competitors’ introductions of new products, quarterly fluctuations in the Company’s financial results, announcements by the Company or its competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures or capital commitments; introduction of technologies or product enhancements that reduce the need for the Company’s products; the loss of, or decrease in sales to, one or more key customers; a large sale of stock by a significant shareholder; dilution from the issuance of the Company’s stock in connection with acquisitions; the addition or removal of our stock to or from a stock index fund; departures of key personnel; the required expensing of stock options or Stock Appreciation Rights (“SARs”); quarterly fluctuations in the Company’s guidance or in the financial results of other semiconductor companies or personal computer companies; changes in the expectations of market analysts or investors, or general conditions in the semiconductor industry or financial markets. In addition, stock markets in general have experienced extreme price and volume volatility in recent years. This volatility has often had a significant impact on the stock prices of high technology companies, at times for reasons that appear unrelated to business performance. The Company’s stock price experienced significant volatility in fiscal year 2012 and 2011, and the Company’s stock price may continue to experience significant volatility in the future.

The volatility of the stock price itself can impact the Company’s earnings because volatility is one measurement that is used in calculating the value of stock-based compensation to employees. In particular, changes in stock price can materially affect the periodic compensation expense associated with SARs, which is remeasured quarterly. The variability of SAR compensation charges may itself affect the ultimate stock price of the Company by making its stock less attractive to certain investors. SARs also represent a potential drain on the cash of the Company, which could leave it with insufficient cash to manage its business.
 
THE COMPANY HAS A CONCENTRATED CUSTOMER BASE, MUST SATISFY DEMANDING PRICE, TECHNOLOGY AND QUALITY REQUIREMENTS, AND IS SUBJECT TO INTEGRATION RISKS
 
Product Development, Quality and Technological Change  — The Company’s growth is highly dependent upon the successful development and timely introduction of new products at competitive prices and performance levels, with the potential to earn gross profit margins acceptable to the Company. The success of new products depends on various factors, including timely completion of product development programs, the availability of third party intellectual property on reasonable terms and conditions, market acceptance of the Company’s and its customers’ new products, achieving acceptable production yields, securing sufficient capacity at a reasonable cost for the Company’s products and the Company’s ability to offer these new products at competitive prices.  The Company’s plans for fiscal year 2013 anticipate the timely introduction of a number of important new products and as such, the Company’s results could be materially adversely affected if these products are not released according to schedule.
 
The Company’s products are generally designed into its customers’ products through a competitive process that evaluates the Company’s product features, price, and many other considerations. In order to succeed in having the Company’s products incorporated into new products being designed by its customers, the Company seeks to anticipate market trends and meet performance, quality and functionality requirements of such customers and seeks to successfully develop and manufacture products that adhere to these requirements. In addition, the Company is expected to meet the timing and price requirements of its customers and must make such products available in sufficient quantities. There can be no assurance that the Company will be able to identify market trends or new product opportunities, develop and market new products, achieve design wins or respond effectively to new technological changes or product announcements by others.
 
 
The semiconductor industry is in constant transition to smaller geometry technologies. These smaller technologies typically require far greater initial investment by the Company, and involve significantly more expensive mask sets.  They may also pose greater technological challenges.  The Company must continually attempt to determine what geometries it should employ to produce new or existing parts, and the right time to change geometries. The Company’s financial results could be adversely affected materially if it is delayed in implementing, or is unable to successfully implement, smaller geometry technologies, if yields are less than expected, or if actual revenues from the smaller geometries are insufficient to produce an appropriate return on investment.

Many of the Company’s products offer additional features or functionality that works in tandem with a primary chip. Demand for many of the Company’s products could suffer, and the Company’s results could be materially affected adversely, if the features and functionality offered by the Company are integrated into a system on the primary chip.  The Company currently believes that the risk of integration is one of the most significant competitive threats facing the Company. Although the Company constantly tries to add value to its chips and to anticipate trends to reduce the risk of integration, there can be no assurance that the Company will be successful in these endeavors.
 
Although the Company has significant processes and procedures in place in an attempt to guarantee the quality of its products, there can also be no assurance that the Company will not suffer unexpected yield or quality issues that could materially affect its operating results. The Company’s products are complex and may contain errors, particularly when first introduced or as new versions are released. The Company relies primarily on in-house testing and quality personnel to design test operations and procedures to detect any errors prior to delivery of its products to its customers. Should problems occur in the operation or performance of the Company’s ICs, it may experience delays in meeting key introduction dates or scheduled delivery dates to its customers. These errors also could cause the Company to incur significant re-engineering costs, divert the attention of its engineering personnel from its product development efforts and cause significant customer relations and business reputation problems. Furthermore, a supply interruption or quality issue could result in claims by customers for recalls or rework of finished goods containing components supplied by the Company. Such claims can far exceed the revenues received by the Company for the sale of such products. Although the Company attempts to mitigate such risks via errors and omissions insurance, contractual terms, and maintaining buffer stocks of inventory, there can be no assurance that the Company will not receive such claims in the future, or that the Company will be able to maintain its customers if it refuses to be responsible for some portion of these claims.  The Company currently does not maintain recall insurance because of its expense and because the Company has not faced a significant recall issue in recent history.

As part of its product development cycle, the Company often is required to make significant investments well before it can expect to receive revenue from those investments. For example, investments to produce semiconductors for automotive companies, even if successful, may not result in a product appearing in an automobile and associated revenue until many years later. The long lead-time between investment and revenue may increase the risk associated with such investments. The Company’s operating results may be adversely affected if the product development cycle is delayed, or if the Company chooses the wrong products to invest in, or if product development costs exceed budgets.
 
The Company’s future growth will depend, among other things, upon its ability to continue to expand its products into new markets. To the extent that the Company attempts to compete in new markets, it may face competition from suppliers that have well-established market positions and products that have already been proven to be technologically and economically competitive. There can be no assurance that the Company will be successful in displacing these suppliers in the targeted applications.
 
Price Erosion  — The semiconductor industry is characterized by intense competition. Historically, average selling prices in the semiconductor industry generally, and for the Company’s products in particular, have declined significantly over the life of each product. While the Company expects to reduce the average prices of its products over time as it achieves manufacturing cost reductions, competitive and other pressures may require the reduction of selling prices more quickly than such cost reductions can be achieved. If not offset by reductions in manufacturing costs or by a shift in the mix of products sold toward higher-margin products, declines in the average selling prices could reduce profit margins.

Strategic Relationships with Customers  — The Company’s future success depends in significant part on strategic relationships with certain of its customers. If these relationships are not maintained, or if these customers develop their own solutions, adopt a competitor’s solution, or choose to discontinue their relationships with SMSC, the Company’s operating results could be adversely affected.
 
In the past, the Company has relied on its strategic relationships with certain customers who are technology leaders in its target markets. The Company intends to pursue and continue to form these strategic relationships in the future. These relationships often require the Company to develop new products that typically involve significant technological challenges. These customers frequently place considerable pressure on the Company to meet their tight development schedules and impose stringent confidentiality and other requirements on the Company. Accordingly, the Company may have to devote a substantial portion of its resources to these strategic relationships, which could detract from or delay completion of other important development projects.
 
Some of the Company’s important end user customers are relying more heavily on original design manufacturers (“ODMs”) to make decisions as to which components are incorporated into their products. The Company’s results may be adversely affected if it fails to maintain effective relationships with these ODMs.
 
Customer Concentration and Shipments to Distributors  — A limited number of customers account for a significant portion of the Company’s sales and revenues. The Company’s sales and revenues from any one customer can fluctuate from period to period depending upon market demand for that customer’s products, the customer’s inventory management of the Company’s products and the overall financial condition of the customer. Loss of an important customer, or deteriorating results from an important customer, such as North American computer makers, could adversely impact the Company’s operating results.
 
 
A significant portion of the Company’s product sales are made through distributors. The Company’s distributors generally offer products from several different suppliers, including products that may be competitive with the Company’s products. Accordingly, there is risk that these distributors may give higher priority to products of other suppliers, thus reducing their efforts to sell the Company’s products. In addition, the Company’s agreements with its distributors are generally terminable at the distributor’s option. No assurance can be given that future sales by distributors will continue at current levels or that the Company will be able to retain its current distributors on acceptable terms. A reduction in sales efforts by one or more of the Company’s current distributors or a termination of any distributor’s relationship with the Company could have an adverse effect on the Company’s operating results.
 
The Company does not have long-term purchase contracts or commitments from its customers, and substantially all of the Company’s sales are made on a purchase order basis. Therefore, customers may decide to significantly alter their purchasing patterns without penalty and with little advance notice. Also, we do not generally obtain letters of credit, credit insurance, or other security for payment from customers or distributors. Accordingly, we are typically not protected against accounts receivable default or bankruptcy by these entities. Our ten largest customers or distributors represent a substantial majority of our accounts receivable. If any such customer or distributor were to become insolvent or otherwise not satisfy its obligations to us, the Company’s financial position could be materially adversely impacted.
 
Product sales and associated gross profit from shipments to the Company’s distributors, other than to distributors in Japan, are deferred until the distributors resell the products. Shipments to distributors, other than to distributors in Japan, are made under agreements allowing price protection and limited rights to return unsold merchandise. The Company’s revenue recognition is therefore highly dependent upon receiving pertinent, accurate and timely data from its distributors. Distributors routinely provide the Company with product, price, quantity and end customer data when products are resold, as well as report the quantities of the Company’s products that are still in their inventories. In determining the appropriate amount of revenue to recognize, the Company uses this data and applies judgment in reconciling any differences between the distributors’ reported inventories and shipment activities. Although this information is reviewed and verified for accuracy, any errors or omissions made by the Company’s distributors and not detected by the Company, if material, could affect reported operating results.
 
As a component manufacturer, the overwhelming majority of products made by the Company are shipped to third parties for integration with or into other products. The third parties then sell their product, containing the Company’s components, to other integrators or to the ultimate commercial customer. If these third party integrators experience delays in developing or manufacturing their products, quality problems, or are unable to satisfy their customer’s demand for any reason, demand for the Company’s products will be adversely affected. Shortages of other components used along with the Company’s products could also delay purchases of the Company’s products. These matters could materially affect the Company’s revenues and profitability.
 
Seasonality of the Business  — The Company’s business historically has been subject to repeated seasonality, with the first and last quarters of each fiscal year tending to be weaker than the second and third quarters. The seasonality of the Company’s business may adversely impact the Company’s stock price and result in additional volatility in its results of operations. Because the Company expects a certain degree of seasonality in its results, it may fail to recognize an actual downturn in its business, and continue to make investments or other business decisions that adversely affect its business in the future.

Credit Issues  — The Company attempts to mitigate its credit risk by doing business only with creditworthy entities and by managing the amount of credit extended to its customers. However, the Company may choose to extend credit to certain entities because it is necessary to support the requirements of an important customer or for other reasons. In the past the Company has had to take certain charges against earnings as a result of the inability of certain of its customers to pay for goods received. There can be no assurance that the Company will not incur similar charges in the future.
 
THE COMPANY’S ‘FABLESS’ MANUFACTURING MODEL IS HEAVILY CONCENTRATED IN ASIA AND DEPENDENT ON A SMALL NUMBER OF WAFER, ASSEMBLY AND TEST COMPANIES WHO POSSESS NEGOTIATING LEVERAGE. THE COMPANY IS AT TIMES REQUIRED TO COMMIT TO CERTAIN PURCHASE QUANTITIES TO SECURE CAPACITY, AND IS SUBJECT TO FLUCTUATIONS IN COMMODITY PRICES AND AVAILABILITY
 
Business Concentration in Asia  — A significant number of the Company’s foundries and subcontractors are located in Asia. Many of the Company’s customers also manufacture in Asia or subcontract to Asian companies. A significant portion of the world’s personal computer component and circuit board manufacturing, as well as personal computer assembly, occurs in Asia, and many of the Company’s suppliers and customers are based in, or do significant business in, both Taiwan and the People’s Republic of China. In addition, many companies are expanding their operations in Asia in an attempt to reduce their costs, and the Company is also exploring relationships with companies in Asia as part of its ongoing efforts to make its supply chain more efficient.   In addition, the Company is concentrating its warehousing of product in Taiwan to introduce greater efficiencies in its supply chain. This concentration of manufacturing and selling activity in Asia, and in Taiwan in particular, poses risks that could affect the supply and cost of the Company’s products, including currency exchange rate fluctuations, economic and trade policies and the political environment in Taiwan, China and other Asian countries. For example, legislation in the United States restricting or adding tariffs to imported goods could adversely affect the Company’s operating results.
 
The Company also may have difficulty competing with companies whose primary presence is in Asia. These companies may be able to develop more intimate customer relationships with Asian OEMs and ODMs because of their physical proximity to these customers, larger presence in Asia, and cultural ties.   The Company’s results may be materially affected adversely if it is unable to successfully compete with its Asian competitors.
 
The risk of earthquakes in China, Taiwan and the Pacific Rim region is significant due to the proximity of major earthquake fault lines in the area. We currently are covered by insurance against business disruption, earthquakes and flooding in this region on a limited basis, but in all instances such insurance is not currently available on terms that are commercially reasonable. Earthquakes, fire, flooding, lack of water or other natural disasters in Taiwan or the Pacific Rim region, or an epidemic, political unrest, war, labor strike or work stoppage in countries where our semiconductor manufacturers, assemblers and test subcontractors are located, likely would result in the disruption of our foundry, assembly or test capacity. There can be no assurance that alternate capacity could be obtained on commercially reasonable terms, if at all.
 
Reliance upon Subcontract Manufacturing  — The vast majority of the Company’s products are manufactured, assembled and tested by independent foundries and subcontract manufacturers under a “fabless” manufacturing model. This reliance upon foundries and subcontractors involves certain risks, including potential lack of manufacturing availability, reduced control over delivery schedules, the availability of advanced process technologies, changes in manufacturing yields, dislocation, expense and delay caused by decisions to relocate or close manufacturing facilities or processes, and potential cost fluctuations. During downturns in the semiconductor economic cycle, such as the recent global economic recession, reduction in overall demand for semiconductor products could financially stress certain of the Company’s subcontractors. If the financial resources of such independent subcontractors are stressed, the Company may experience future product shortages, quality assurance problems, increased manufacturing costs or other supply chain disruptions.
 
During upturns in the semiconductor cycle, it is not always possible to respond adequately to unexpected increases in customer demand due to capacity constraints. The Company may be unable to obtain adequate foundry, assembly or test capacity from third-party subcontractors to meet customers’ delivery requirements even if the Company adequately forecasts customer demand. Alternatively, the Company may have to incur unexpected costs to expedite orders in order to meet unforecasted customer demand. The Company typically does not have long-term supply contracts with its third-party vendors that obligate the vendor to perform services and supply products for a specific period, in specific quantities, and at specific prices. The Company’s third-party foundry, assembly and test subcontractors typically do not guarantee that adequate capacity will be available within the time required to meet customer demand for products. In the event that these vendors fail to meet required demand for whatever reason the Company expects that it would take up to twelve months to transition performance of these services to new providers. Such a transition may also require qualification of the new providers by the Company’s customers or their end customers, which would take additional time. The requalification process for the entire supply chain including the end customer could take several years for certain of the Company’s products, particularly automotive products.  The Company may also suffer delays in production or quality problems if its vendors move production from one facility to another facility owned by them.  The Company may also have to requalify products that have been moved to a new production facility within the same vendor, and may also suffer production delays as a result of the requalification process.  The Company generally does not have the right to restrict such transfers.

As a result of a certain manufacturer plant closings at which wafers for a particular product are being made, the Company has made a significant investment in certain automotive inventory before the plant closes in order to assure continuity of supply for this product.   The Company’s results may be adversely affected if it purchases insufficient inventory to assure continuity of supply, or if it purchases too much inventory and is forced to write-off some portion of its investment.  During the third quarter of fiscal 2012, the Company recorded an inventory impairment of $2.2 million in connection with this inventory.
 
In the past, the Company received several unexpected price increases from several entities that assemble or package products. In the past there have been periods of shortage of capacity among companies that supply assembly services. The Company’s contracts also generally do not protect it from price increases in certain base commodities used in the semiconductor manufacturing process. The Company’s results in recent fiscal years were adversely affected by significant increases in the price of gold. The Company is restructuring certain manufacturing processes to use copper instead of gold in its products. Although the Company resists attempts by suppliers to increase prices, there can be no assurance that the Company’s margins will not be impacted in fiscal year 2013 or other future periods as a result of a shortage of capacity, changes in commodity prices, or price increases in assembly or other services. Because at various times the capacity of either wafer producers or assemblers can been limited, the Company may be unable to satisfy the demand of its customers, or may have to accept price increases or other compensation arrangements that increase its operating expenses and erode its margins.
 
Forecasts of Product Demand  — The Company generally must order inventory to be built by its foundries and subcontract manufacturers well in advance of product shipments. Production is often based upon either internal or customer-supplied forecasts of demand, which can be highly unpredictable and subject to substantial fluctuations. Because of the volatility in the Company’s markets, there is risk that the Company may forecast incorrectly and produce excess or insufficient inventories. In addition, the Company is sometimes the only supplier of a particular part to a customer. The value of the product line using the Company’s product may far exceed the value of the particular product sold by the Company to its customer. The Company may be forced to carry additional inventory of certain products to insure that its customers avoid production interruptions and to avoid claims being made by its customers for supply shortages. The Company’s revenue and profitability may be adversely affected if it fails to execute properly on this strategy, and causes supply chain problems for its customers due to insufficient inventory.
 
 
Prior to purchasing the Company’s products, customers require that products undergo an extensive qualification process, which involves testing of the products in the customer’s system as well as rigorous reliability testing. This qualification process may continue for six months or longer. However, qualification of a product by a customer does not ensure any sales of the product to that customer. Even after successful qualification and sales of a product to a customer, a subsequent revision to the integrated circuit or software, changes in the integrated circuit’s manufacturing process or the selection of a new supplier by us may require a new qualification process, which may result in delays and in us holding excess or obsolete inventory. After products are qualified, it can take an additional six months or more before the customer commences volume production of components or devices that incorporate these products. Despite these uncertainties, the Company devotes substantial resources, including design, engineering, sales, marketing and management efforts, toward qualifying its products with customers in anticipation of sales. If the Company is unsuccessful or delayed in qualifying any products with a customer, such failure or delay would preclude or delay sales of such product to the customer, which may impede the Company’s growth and cause its business to suffer.

Business Process Re-Engineering Project — In an attempt to introduce greater efficiencies in its supply chain and its overall business processes, the Company implemented a significant business process re-engineering project (“BPRE”) on April 14, 2011 for many of its product lines. BPRE involved changes to the Company’s order and purchase flow, changes to its enterprise software system, changes to accounting and finance processes, and numerous other matters. As a result of BPRE, a substantial part of the Company’s cash generation and accumulation is occurring outside the United States.  Under current regulations, there is additional taxation associated with repatriating such funds to the United States.  If the Company lacks sufficient funds located in the United States, this may negatively affect its ability to fund the businesses located in the United States. The Company’s results may also be negatively affected if BPRE does not produce its expected benefits.
 
THE COMPANY HAS GLOBAL OPERATIONS SUBJECT TO RISKS THAT MAY HARM RESULTS OF OPERATIONS AND FINANCIAL CONDITION
 
Global Operations Risks — The Company has sales, R&D, and operations facilities in many countries, and as a result, is subject to risks associated with doing business globally. SMSC’s global operations may be subject to risks that may limit our ability to build product, design, develop, or sell products in particular countries, which could, in turn, harm our results of operations and financial condition, including;

 
·
Security concerns, such as armed conflict and civil or military unrest, crime, political instability, and terrorist activity;
 
·
Acts of nature, such as typhoons, tsunamis volcanoes or earthquakes;
 
·
Infrastructure disruptions, such as large-scale outages or interruptions of service from utilities or telecommunications providers, could in turn cause supply chain interruptions;
 
·
Regulatory requirements and prohibitions that differ between jurisdictions; and
 
·
Restrictions on our operations by governments seeking to support local industries, nationalization of our operations, and restrictions on our ability to repatriate earnings.

In addition, although most of the Company’s products are priced and paid for in U.S. dollars, a significant amount of certain types of expenses, such as payroll, utilities, tax, and marketing expenses, are paid in local currencies, and therefore fluctuations in exchange rates could harm the Company’s business operating results and financial condition. In addition, changes in tariff, export and import regulations, and U.S. and non-U.S. monetary policies, may harm our operating results and financial condition by increasing our expenses and reducing our revenue. Varying tax rates in different jurisdictions could harm our operating results and financial condition by increasing the Company’s overall effective tax rate.  Fiscal 2012 tax rates were substantially higher than anticipated as a result of a shortfall in profits earned outside of the United States in lower tax jurisdictions; if such situations occur in the future the Company’s profitability could be similarly adversely affected.
 
Although the Company’s operations are global, its information technology infrastructure is concentrated at its headquarters in Hauppauge, New York.   Although the Company maintains redundant systems at its headquarters, a natural or other disaster could disable all systems maintained by the Company in New York, which could materially adversely affect the Company’s ability to do business on a global basis, and its revenues and profitability.  While the Company does maintain a disaster plan, there is no guarantee that the disaster plan will be sufficient to prevent the Company from being materially adversely affected in the event of a disaster.

Cyberattacks and industrial espionage have become an increasingly important problem for high technology companies.   Although the company is not aware of it ever being subject to a cyberattack or industrial espionage, there can be no guarantee that such episodes will not occur in the future.   Likewise, the Company may have been subject to such attacks in the past without being aware of the incident.
 
 
THE COMPANY’S SUCCESS DEPENDS ON THE EFFECTIVENESS OF ITS ACQUISITIONS, RETAINING AND INTEGRATING KEY PERSONNEL, MANAGING INTELLECTUAL PROPERTY RISKS AND GROWTH AND MAINTAINING A PROPER CAPITAL STRUCTURE
 
Strategic Business Acquisitions — The Company has made strategic acquisitions of or investments in complementary businesses, products and technologies in the past, including the OASIS acquisition in 2005, the BridgeCo acquisition in 2011 and several smaller transactions in fiscal year 2010 and 2011, and expects to continue to pursue such acquisitions in the future as business conditions warrant. Business acquisitions and investments can involve numerous risks, including: unanticipated costs and expenses; risks associated with entering new markets in which the Company has little or no prior experience; diversion of management’s attention from its existing businesses; potential loss of key employees, particularly those of the acquired business; differences between the culture of the acquired company and the Company, difficulties in integrating the new business into the Company’s existing businesses; potential dilution of future earnings; and future impairment and write-offs of the investment, purchased goodwill, other intangible assets and fixed assets due to unforeseen events and circumstances. The Company wrote off approximately $52 million worth of goodwill, in connection with the OASIS acquisition in fiscal year 2009, and incurred impairment losses of $6.7 million in connection with the Symwave acquisition in fiscal 2011. Although the Company believes it has managed the OASIS and BridgeCo acquisitions well to date, there is no guarantee that the OASIS, BridgeCo or other acquisitions in the future will produce the benefits intended. Future acquisitions also could cause the Company to incur debt or contingent liabilities or cause the Company to issue equity securities that could negatively impact the ownership percentages of existing shareholders.
 
Protection of Intellectual Property  — The Company has historically devoted significant resources to research and development activities and believes that the intellectual property derived from such research and development is a valuable asset that has been, and will continue to be, important to the Company’s success. The Company relies upon nondisclosure agreements, contractual provisions and patent and copyright laws to protect its proprietary rights. No assurance can be given that the steps taken by the Company will adequately protect its proprietary rights, or that competitors will be prevented from using the Company’s intellectual property. During its history, the Company has executed patent cross-licensing agreements with many of the world’s largest semiconductor suppliers, under which the Company receives and conveys various intellectual property rights. Many of these agreements are still effective. The Company could be adversely affected should circumstances arise that result in the early termination of these agreements. In addition, the Company also frequently licenses intellectual property from third parties to meet specific needs as it develops its product portfolio. The Company’s competitive position and its results could be adversely affected if it is unable to license desired intellectual property at all, or on commercially reasonable terms.
 
Infringement and Other Claims  — Companies in the semiconductor industry often aggressively protect and pursue their intellectual property rights.  In addition to actual competitors, companies known as “patent trolls”, which exist primarily to purchase and enforce intellectual property rights, have become a larger presence in the marketplace. From time to time, the Company has received, and expects to continue to receive notices from competitors and patent trolls claiming that the Company has infringed upon or misused other parties’ proprietary rights, or claims from its customers for indemnification for intellectual property matters. The Company has also in the past received, and may again in the future receive, notices of claims related to business transactions conducted with third parties, including asset sales and other divestitures.
 
If it is determined that the Company’s or its customer’s products or processes were to infringe on other parties’ intellectual property rights, a court might enjoin the Company or its customer from further manufacture and/or sale of the affected products. The Company would then need to obtain a license from the holders of the rights and/or reengineer its products or processes in such a way as to avoid the alleged infringement. There can be no assurance that the Company would be able to obtain any necessary license on commercially reasonable terms acceptable to the Company or that the Company would be able to reengineer its products or processes to avoid infringement. An adverse result in litigation arising from such a claim could involve the assessment of a substantial monetary award for damages related to past product sales that could have a material adverse effect on the Company’s results of operations and financial condition. In addition, even if claims against the Company are not valid or successfully asserted, defense against the claims could result in significant costs and a diversion of management and resources. The Company might also be forced to settle such a claim even if not valid as a result of pressure from its customers, because of the expense of defense, or because the risk of contesting such a claim is simply too great. Such settlements could adversely affect the Company’s profitability.

Dependence on Key Personnel  — The success of the Company is dependent in large part on the continued service of its key management, engineering, marketing, sales and support employees. Competition for qualified personnel is intense in the semiconductor industry, and the loss of current key employees, or the inability of the Company to attract other qualified personnel, including the inability to offer competitive stock-based and other compensation, could hinder the Company’s product development and ability to manufacture, market and sell its products. We believe that our future success will be dependent on retaining the services of our key personnel, developing their successors and certain internal processes to reduce our reliance on specific individuals, and on properly managing the transition of key roles when they occur.
 
Proper Capital Structure — The Company’s capital structure is a key ingredient in the Company’s ability to conduct business and overall profitability.  The Company currently has no bank debt.   The Company’s results could be adversely affected if it creates a capital structure that limits its flexibility to conduct business in an optimal fashion, or if it passes on opportunities in order to maintain a particular capital structure.
 
 
THE COMPANY’S RESULTS COULD BE ADVERSELY AFFECTED FROM FAILURE TO COMPLY WITH LEGAL AND REGULATORY REQUIREMENTS
 
Internal Controls Over Financial Reporting  — Section 404 of the Sarbanes-Oxley Act of 2002 requires the Company to evaluate the effectiveness of its system of internal controls over financial reporting as of the end of each fiscal year, beginning with fiscal 2005, and to include a report by management assessing the effectiveness of its system of internal controls over financial reporting within its annual report.
 
The Company’s management does not expect that its system of internal controls over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must recognize that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, involving the Company have been, or will be, detected. These inherent limitations include faulty judgments in decision-making and breakdowns that may occur because of simple error or mistake.  Many of the Company’s operations are located overseas, where the personnel need to be trained on United States legal and financial regulations, and may be used to conducting business under different standards and regulations. Controls can also be circumvented by individual acts, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and the Company cannot provide assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. In addition, because of the Company’s revenue recognition policies, the accuracy of the Company’s financial statements is dependent on data received from third party distributors, and will also be dependent on the accuracy of data from the BPRE implementation.  Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
 
Although the Company’s management has concluded that its system of internal controls over financial reporting was effective as of February 29, 2012, there can be no assurance that the Company or its independent registered public accounting firm will not identify a material weakness in the system of internal controls over financial reporting in the future. A material weakness in the Company’s system of internal controls over financial reporting would require management and/or the Company’s independent registered public accounting firm to evaluate the Company’s system of internal controls as ineffective. This in turn could lead to a loss of public confidence, which could adversely affect the Company’s business and the price of its common stock.
 
Corporate Governance  — In recent years, the NASDAQ Global Select Market, on which the Company’s common stock is listed, has adopted comprehensive rules and regulations relating to corporate governance.  The United States government in 2010 also passed legislation concerning numerous governance matters for which the implementing regulations have not yet been adopted. These laws, rules and regulations have increased, and may continue to increase, the scope, complexity and cost of the Company’s corporate governance, reporting and disclosure practices. Failure to comply with these rules and regulations could adversely affect the Company, and in a worst case, result in the delisting of its stock. As a result of these rules, the Company’s board members, Chief Executive Officer, Chief Financial Officer and other corporate officers could also face increased risks of personal liability in connection with the performance of their duties. As a result, the Company may have difficulty attracting and retaining qualified board members and officers, which would adversely affect its business. Further, these developments could affect the Company’s ability to secure desired levels of directors’ and officers’ liability insurance, requiring the Company to accept reduced insurance coverage or to incur substantially higher costs to obtain coverage.

Environmental, Conflict Mineral and Other Regulation  — Environmental regulations and standards are established worldwide to control discharges, emissions, and solid wastes from manufacturing processes. Within the United States, federal, state and local agencies establish these regulations. Outside of the United States, individual countries and local governments establish their own individual standards. The Company believes that its activities conform to present environmental regulations and historically the effects of this compliance have not had a material effect on the Company’s capital expenditures, operating results, or competitive position. Future environmental compliance requirements, as well as amendments to or the adoption of new environmental regulations or the occurrence of an unforeseen circumstance could subject the Company to fines or require the Company to acquire expensive remediation equipment or to incur other expenses to comply with environmental regulations.

The United States Congress recently passed legislation requiring the disclosure of the provenance of certain minerals, known as "conflict minerals", that are thought to finance armed groups in central Africa. Certain minerals used by the Company, in particular gold, are the subject of this legislation. The implementing regulations for this legislation have not yet been finalized. The Company may face SEC action as well as reputational harm if it fails to comply with the disclosure obligations of this legislation. Compliance with this legislation will result in additional expense related to expanded monitoring of the Company's supply chain and could result in the Company restricting or modifying the sources from which it acquires key minerals needed to manufacture its products, which could adversely affect its revenues and profitability.
 
In addition, many of the Company’s customers belong to trade groups or other similar bodies that are creating their own private governance, health, safety and environmental standards. Some of these customers are mandating that the Company comply with these standards as a condition to selling product to these customers. The Company’s sales and profitability may suffer if it is unable to satisfy these private standards, or if complying with these standards imposes significant costs on the Company.

 
The Company has received no written comments from the SEC staff regarding its periodic or current reports as filed under the Securities Exchange Act of 1934, nor on any filings made pursuant to the Securities Act of 1933, that remain unaddressed or unresolved as of the filing date of this Report.
 
SMSC’s headquarters facility is located in Hauppauge, New York, where it conducts research, development, warehousing, shipping, marketing, selling and administrative activities. As of February 29, 2012, the Company owned the 200,000 square foot building at this location in connection with an arrangement with the Suffolk County Industrial Development Agency. Effective March 14, 2012, the Company has assigned its interest in its headquarters facility to Rep 80 Arkay Drive, LLC (“Rep 80”) pursuant to a sale/leaseback transaction. See Part IV Item 15(a)(1) — Financial Statements — Note 19, for additional information.

In addition, the Company maintains material office space in leased facilities as follows:

 
Location
 
 
Activities
 
Approximate
Square Footage
 
 
Lease Expiration
Austin, Texas
 
Engineering, Logistics, Marketing & Sales
 
63,138
 
June 30, 2019
Karlsruhe, Germany
 
Engineering, Logistics, Marketing & Sales
 
39,826
 
June 30, 2013
Bangalore, India
 
Engineering
 
               17,263
 
October 14, 2015
Phoenix, Arizona
 
Engineering & Marketing
 
17,227
 
March 31, 2013
Tucson, Arizona
 
Engineering, Marketing
 
16,000
 
July 31, 2020
Chennai, India
 
Engineering
 
13,913
 
May 31, 2019
Bangalore, India
 
Engineering
 
                 8,813
 
December 31, 2012
Taipei, Taiwan
 
Logistics, Marketing & Sales
 
7,543
 
December 30, 2014
Sofia, Bulgaria
 
Engineering
 
7,388
 
March 31, 2015
Hong Kong
 
Logistics and Sales
 
6,892
 
May 31, 2013
Pforzheim, Germany
 
Engineering
 
5,651
 
February 28, 2022
Irvine, California
 
Engineering & Marketing
 
5,475
 
August 31, 2017
Amsterdam, The Netherlands
 
Engineering
 
4,230
 
October 31, 2012
 
The table above does not include those leased facilities which are below 4,000 square feet and are not strategically significant.
 
The Company believes that all of its facilities are in good condition, adequate for intended use and sufficient for its immediate needs. The Company currently expects to either renew existing leases or identify suitable alternative leased space for all leases expiring in fiscal 2013. It is not certain whether the Company will negotiate new leases on its other facilities where such leases expire subsequent to fiscal 2013 and beyond. Such determinations will be made as those leases approach expiration and will be based on an assessment of requirements and market conditions at that time. Further, management believes that additional space can be readily obtained, if necessary, based on prior experience and current and expected real estate market conditions.
 
 
From time to time as a normal consequence of doing business, various claims and litigation have been asserted or commenced against the Company. In particular, the Company in the ordinary course of business may receive claims that its products infringe the intellectual property of third parties, or that customers have suffered damage as a result of defective products allegedly supplied by the Company. Due to uncertainties inherent in litigation and other claims, the Company can give no assurance that it will prevail in any such matters, which could subject the Company to significant liability for damages and/or invalidate its proprietary rights. Any lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management’s time and attention, and an adverse outcome of any significant matter could have a material adverse effect on the Company’s consolidated results of operations or cash flows in the quarter or annual period in which one or more of these matters are resolved.


PART II
 
 
Market Information and Holders
 
The Company’s common stock is traded in the over-the-counter market under the NASDAQ symbol SMSC. Trading is reported in the NASDAQ Global Select Market. There were approximately 642 holders of record of the Company’s common stock at February 29, 2012.
 
 
The following table sets forth the high and low trading prices, for the periods indicated, for SMSC’s common stock as reported by the NASDAQ Global Select Market:
 
   
Fiscal 2012
   
Fiscal 2011
 
   
High
   
Low
   
High
   
Low
 
First Quarter
  $ 27.83     $ 22.67     $ 27.85     $ 19.67  
Second Quarter
  $ 27.78     $ 19.02     $ 25.55     $ 17.80  
Third Quarter
  $ 25.83     $ 17.98     $ 27.39     $ 18.31  
Fourth Quarter
  $ 27.52     $ 23.15     $ 30.40     $ 23.33  

Dividend Policy
 
The present policy of the Company is to retain earnings to provide funds for the operation and expansion of its business. The Company has never paid a cash dividend and does not currently expect to pay cash dividends in the foreseeable future.
 
Securities Authorized for Issuance Under Equity Compensation Plans
 
The information under the caption “Equity Compensation Plan Information,” appearing in the 2012 Proxy Statement related to the 2012 Annual Meeting of Stockholders (the “2012 Proxy Statement”), is hereby incorporated by reference. For additional information on the Company’s stock-based compensation plans, refer to Part IV Item 15(a)(1) — Financial Statements — Note 12.
 
Common Stock Repurchase Program
 
In October 1998, the Company’s Board of Directors approved a common stock repurchase program, allowing the Company to repurchase up to one million shares of its common stock on the open market or in private transactions. The Board of Directors authorized the repurchase of additional shares in one million share increments in July 2000, July 2002, November 2007 and April 2008, and an additional two million shares in May 2011, bringing the total authorized repurchases to seven million shares as of February 29, 2012. As of February 29, 2012, the Company has repurchased approximately 5.8 million shares of its common stock at a cumulative cost of $131.2 million under this program, including 1,338,349 shares repurchased at a cost of $30.0 million in fiscal 2012. There was no share repurchase activity in fiscal 2010 or 2011.

The Company withheld 4,821 and 38,972 shares at a cost of $0.1 million and $1.0 million in the three and twelve month periods ended February 29, 2012, respectively, as part of an ongoing program to fund employee tax withholdings required on restricted shares vesting each period.

Stock Performance Graph
 
The line graph below compares the cumulative total stockholder return on our common stock with the cumulative total return of the NASDAQ Composite Index and the Philadelphia Semiconductor Index for the five fiscal years ended February 29, 2012. The graph and table assume that $100 was invested on February 28, 2007 (the last day of trading for the fiscal year ended February 28, 2007) in each of our common stock, the NASDAQ Composite Index and the Philadelphia Semiconductor Index, and that all dividends were reinvested.
 
 
As of February 28 or 29,
 
2007
   
2008
   
2009
   
2010
   
2011
   
2012
 
                                     
Standard Microsystems Corporation
  $ 100.00     $ 99.23     $ 54.50     $ 68.32     $ 92.86     $ 89.57  
NASDAQ Composite
  $ 100.00     $ 91.29     $ 57.77     $ 94.42     $ 118.63     $ 123.62  
PHLX Semiconductor
  $ 100.00     $ 91.20     $ 61.63     $ 94.23     $ 121.55     $ 135.12  

Item 6. — Selected Financial Data

Standard Microsystems Corporation and Subsidiaries
SELECTED FINANCIAL DATA

As of February 28 or 29, and for the Fiscal Years Then Ended
 
2012
   
2011
   
2010
   
2009
   
2008
 
   
(in thousands, except per share data)
 
Operating Results:
 
 
   
 
   
 
   
 
   
 
 
Product sales
  $ 407,029     $ 407,396     $ 307,068     $ 316,383     $ 365,671  
Intellectual property and other revenues
    5,075       2,083       710       9,113       12,178  
Total sales and revenues
    412,104       409,479       307,778       325,496       377,849  
Costs of goods sold
    196,446       194,585       154,872       163,861       186,024  
Gross profit
    215,658       214,894       152,906       161,635       191,825  
Research and development
    100,350       96,370       77,702       74,169       71,660  
Selling, general and administrative
    86,706       100,661       85,049       88,123       82,517  
Acquisition termination fee gain
    -       (7,700 )     -       -       -  
Restructuring charges
    1,973       4,703       2,123       5,197       -  
Impairment of goodwill
    -       -       -       52,300       -  
Impairment loss on equity investment (Symwave)
    -       3,208       -       -       -  
Gain on equity investment (Canesta)
    -       (320 )     -       -       -  
Revaluation of contingent acquisition liabilities
    (1,365 )     (4,206 )     -       -       -  
Impairment losses on intangible assets (Symwave)
    -       3,531       -       -       -  
Settlement charge
    -       -       2,019       -       -  
Income (loss) from operations
    27,994       18,647       (13,987 )     (58,154 )     37,648  
Other income, net
    232       258       304       7,556       5,690  
Net income (loss)
  $ 10,662     $ 10,627     $ (7,978 )   $ (49,409 )   $ 32,906  
Diluted net  income (loss) per share
  $ 0.46     $ 0.46     $ (0.36 )   $ (2.22 )   $ 1.39  
Diluted weighted average common shares outstanding
    23,203       23,108       22,133       22,232       23,623  
Balance Sheet and Other Data:
                                       
Cash, cash equivalents and short-term investments
  $ 147,054     $ 170,387     $ 139,641     $ 97,156     $ 61,641  
Long-term investments
  $ 25,680     $ 29,490     $ 42,957     $ 69,223     $ 124,469  
Working capital
  $ 166,827     $ 205,739     $ 171,337     $ 145,886     $ 118,849  
Total assets
  $ 513,986     $ 539,092     $ 479,336     $ 429,686     $ 539,476  
Long-term obligations
  $ 21,001     $ 21,869     $ 22,944     $ 15,625     $ 15,992  
Shareholders’ equity
  $ 394,367     $ 396,907     $ 361,888     $ 348,808     $ 436,089  
Book value per common share
  $ 17.73     $ 17.27     $ 16.16     $ 15.91     $ 19.14  
Capital expenditures
  $ 11,706     $ 12,396     $ 8,616     $ 17,883     $ 13,263  
Depreciation and amortization
  $ 30,424     $ 25,518     $ 25,354     $ 22,346     $ 20,370  

This selected financial data should be read in conjunction with the financial statements as set forth in Part IV Item 15(a)(1) — Financial Statements and Part II. Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The operating results presented above reflect:

 
·
Restructuring charges of $2.0, $4.7, $2.1 and $5.2 million in fiscal 2012, 2011, 2010 and 2009, respectively, as more fully described in Part IV Item 15(a)(1) — Financial Statements — Note 11.

 
·
An acquisition termination fee gain of $7.7 million in fiscal 2011 related to the termination of the Conexant Master Purchase Agreement.

 
·
A gain on revaluation of contingent acquisition liabilities of $1.4 million and $4.2 million in fiscal 2012 and fiscal 2011, respectively, based upon the likelihood of not achieving goals.

 
·
Charges of $6.7 million in fiscal 2011 for the impairment losses related to the Symwave acquisition, as more fully described in Part IV Item 15(a)(1) — Financial Statements — Notes 2 and 4.

 
·
A credit to costs of goods sold of approximately $1.0 million recorded in the fourth quarter of fiscal 2010 for the reduction of accounts payable related to inventory received not invoiced to correct an error from prior periods, as more fully described in Part IV Item 15 (a)(1) — Financial Statements — Note 2.
 
 
 
·
A charge of $2.0 million in settlement of the OPTi, Inc. patent infringement lawsuit against the Company recognized in fiscal 2010.

 
·
A charge of $52.3 million in fiscal 2009 for the impairment of goodwill related to the OASIS acquisition.

 
·
The receipts of $9.0 million and $12.0 million of certain intellectual property payments from Intel Corporation in fiscal 2009 and 2008, respectively.

 
·
Approximately $0.4 million (recorded in the fiscal quarter ended August 31, 2008) of stock-based compensation expense to correct an error relating to prior periods amending the method of amortization for deferred compensation relating to certain restricted stock awards (“RSAs”) granted between March 1, 2006 and May 31, 2008. In addition, the benefit from income taxes includes an additional $0.1 million in net benefit relating to adjustments of certain deferred tax balances (recorded in the fiscal quarter ended February 28, 2009).

 
·
For the twelve month period ended February 28, 2008, charges totaling $1.3 million in its consolidated income tax expense associated with the exercise of incentive stock options, and an additional $0.4 million (net of tax) related to unrealized foreign exchange losses associated with prior periods going back to the first quarter of fiscal 2007. The Company corrected these errors in its fiscal 2008 third quarter results, which had the effect of increasing consolidated income tax expense for the fiscal year ended February 29, 2008 by $1.4 million, increasing other expense by $0.5 million and decreasing consolidated net income by $1.5 million.
 
 
GENERAL
 
The following discussion should be read in conjunction with the Company’s consolidated financial statements and accompanying notes, included in Part IV Item 15(a)(1) — Financial Statements , of this Annual Report on Form 10-K for the fiscal year ended February 29, 2012 (the “Report” or “10-K”).
 
Forward-Looking Statements
 
Portions of this Report may contain forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are based on management’s beliefs and assumptions, current expectations, estimates and projections. Such statements, including statements relating to the Company’s expectations for future financial performance, are not considered historical facts and are considered forward-looking statements under the federal securities laws. Words such as “believe,” “expect,” “anticipate” and similar expressions identify forward-looking statements. Risks and uncertainties may cause the Company’s actual future results to be materially different from those discussed in forward-looking statements. The Company’s risks and uncertainties include the timely development and market acceptance of new products; the impact of competitive products and pricing; the Company’s ability to procure capacity from suppliers and the timely performance of their obligations, commodity prices, interest rates and foreign exchange, potential investment losses as a result of market liquidity conditions, the effects of changing economic and political conditions in the market domestically and internationally and on its customers; relationships with and dependence on customers and growth rates in the personal computer, consumer electronics and embedded and automotive markets and within the Company’s sales channel; changes in customer order patterns, including order cancellations or reduced bookings; the effects of tariff, import and currency regulation; potential or actual litigation; and excess or obsolete inventory and variations in inventory valuation, among others. In addition, SMSC competes in the semiconductor industry, which has historically been characterized by intense competition, rapid technological change, cyclical market patterns, price erosion and periods of mismatched supply and demand.
 
The Company’s forward looking statements are qualified in their entirety by the inherent risks and uncertainties surrounding future expectations and may not reflect the potential impact of any future acquisitions, mergers or divestitures. All forward-looking statements speak only as of the date hereof and are based upon the information available to SMSC at this time. Such statements are subject to change, and the Company does not undertake to update such statements, except to the extent required under applicable law and regulation. These and other risks and uncertainties, including potential liability resulting from pending or future litigation, are detailed from time to time in the Company’s periodic and current reports as filed with the SEC. Readers are advised to review other sections of this Report, including Part I Item 1.A. — Risk Factors, for a more complete discussion of these and other risks and uncertainties. Other cautionary statements and risks and uncertainties may also appear elsewhere in this Report.
 
CRITICAL ACCOUNTING POLICIES & ESTIMATES
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) and SEC rules and regulations requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of sales and revenues and expenses during the reporting period.
 
SMSC believes the following critical accounting policies and estimates are important to the portrayal of the Company’s financial condition, results of operations and cash flows, and require critical management judgments and estimates about matters that are inherently uncertain. Although management believes that its judgments and estimates are appropriate and reasonable, actual future results may differ from these estimates, and to the extent that such differences are material, future reported operating results may be affected.
 
Revenue Recognition
 
Sales and associated gross profit from shipments to the Company’s distributors, other than to distributors in Japan, are deferred until the distributors resell the products. Shipments to distributors, other than to distributors in Japan, are made under agreements allowing price protection and limited rights to return unsold merchandise. In addition, SMSC’s shipments to its distributors may be subject from time to time to short-term fluctuations as distributors manage their inventories to current levels of end-user demand. Therefore, SMSC considers the policy of deferring revenue on shipments to distributors to be a more meaningful presentation of the Company’s operating results, as reported sales are more representative of end-user demand. This policy is a common practice within the semiconductor industry. The Company’s revenue recognition is therefore highly dependent upon receiving pertinent, accurate and timely data from its distributors. Distributors routinely provide the Company with product, price, quantity and end customer data when products are resold, as well as periodic inventory data. In determining the appropriate amount of revenue to recognize, the Company uses this data in reconciling any differences between the distributors’ reported inventories and shipment activities. Although this information is reviewed and verified for accuracy, any errors or omissions made by the Company’s distributors and not detected by the Company, if material, could affect reported operating results.
 
 
Shipments made by the Company’s Japanese subsidiary to distributors in Japan are made under agreements that permit limited or no stock return or price protection privileges. SMSC recognizes revenue from product sales to distributors in Japan, and to original equipment manufacturers (OEMs), as title passes upon delivery, net of appropriate reserves for product returns and allowances.
 
 
Inventories
 
The Company’s inventories are comprised of complex, high technology products that may be subject to rapid technological obsolescence and which are sold in a highly competitive industry. Inventories are valued at the lower of cost (first-in, first-out) or market, and are reviewed at least quarterly for product obsolescence, excess balances and other indications of impairment in value, based upon assumptions of future demand and market conditions. When it is determined that specific inventory is stated at a higher value than that which can be recovered, the Company writes this inventory down to its estimated realizable value with a charge to costs of goods sold. While the Company endeavors to appropriately forecast customer demand and stock commensurate levels of inventory, unanticipated inventory write-downs may be required in future periods relating to inventory on hand as of any reported balance sheet date.

Fair Value Measurements
 
The Company’s financial instruments are measured and recorded at fair value based on inputs and assumptions that market participants would use in pricing an asset or a liability. These assumptions consist of (1) observable inputs—market data obtained from independent sources, or (2) unobservable inputs—market data determined using the Company’s own assumptions about valuation. The Company utilized a three tier hierarchy to prioritize the inputs to valuation techniques, with the highest priority being given to Level 1 inputs and the lowest priority to Level 3 inputs, as described below:
 
Level 1 — Quoted prices for identical instruments in active markets;
 
Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs or significant value-drivers are observable in active markets; and
 
Level 3 — Unobservable inputs.
 
The lowest level of significant input determines the placement of the entire fair value measurement in the hierarchy.

The Company’s non-financial assets (including: goodwill; intangible assets; and, property, plant and equipment) are measured at fair value when there is an indicator of impairment and recorded at fair value only when an impairment charge is recognized.

Stock-Based Compensation
 
The Company has several stock-based compensation plans in effect under which incentive stock options, non-qualified stock options, restricted stock awards (“RSAs”), restricted stock units (“RSUs”), employee stock purchase plan shares and stock appreciation rights (“SARs”) have been granted to employees and directors. Stock options and SARs are granted with exercise prices equal to the fair value of the underlying shares on the date of grant. New shares of common stock are issued in settling stock option exercises and restricted stock awards.
 
The Black-Scholes option pricing model is used for estimating the fair value of options and SARs granted and corresponding compensation expense to be recognized. The Black-Scholes model requires certain assumptions, judgments and estimates by the Company to determine fair value, including expected stock price volatility, risk-free interest rate and expected term. The Company based the expected volatility on historical volatility. The expected term of each individual SARs award is assumed to be the midpoint of the remaining term through expiration as of any remeasurement date. Share-based compensation amounts related to RSAs and RSUs are calculated based on the market price of the Company’s common stock on the date of grant. There were no dividends expected to be paid on the Company’s common stock over the expected lives estimated.

Business Combinations

The Company accounts for business combinations under the acquisition method of accounting and allocates total purchase price for acquired businesses to the tangible and identified intangible assets acquired and liabilities assumed, based on estimated fair values. The excess purchase price over those fair values is recorded as goodwill. The fair values assigned to tangible and identified intangible assets acquired and liabilities assumed are based on management estimates and assumptions that utilize established valuation techniques appropriate for the semiconductor industry and each acquired business consistent with market participant assumptions. A liability for contingent consideration, if applicable, is recorded at fair value as of the acquisition date. In determining the fair value of such contingent consideration, management estimates the amount to be paid based on probable outcomes and expectations of financial performance of the related acquired business. The fair value of contingent consideration is reassessed quarterly, with any change in expected value charged to results of operations.
 
Investments in Equity Securities

Investments in equity securities representing less than a controlling interest are carried at cost, unless facts and circumstances indicate that either (i) the Company has significant influence over the operations of the investment and therefore accounts for the investment under the equity method or (ii) consolidation of the related business is warranted, as may be the case if such were deemed to be a variable interest entity. The cost of such investments is reflected in the Investments in equity securities caption of the Company's consolidated balance sheets, and are periodically reviewed for indications of impairment in value. The cost basis of any investment for which potential indications of impairment exist that were deemed other than temporary would be reduced accordingly, with a charge to results of operations.

Allowance for Doubtful Accounts
 
The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. These estimated losses are based upon historical bad debts, specific customer creditworthiness and current economic trends. The Company regularly performs credit evaluations consisting primarily of reviews of its customers’ financial condition, using information provided by the customers as well as publicly available information, if any. If the financial condition of an individual customer or group of customers deteriorates, resulting in such customers’ inability to make payments within approved credit terms, additional allowances may be required.

Valuation of Long-Lived Assets
 
Long-lived Assets

Long-lived assets, including definite-lived intangible assets and property, plant and equipment are monitored and reviewed for impairment in value whenever events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. The determination of recoverability is based on an estimate of undiscounted cash flows expected to result from the use of the related asset and its eventual disposition. The estimated cash flows are based upon, among other things, certain assumptions about expected future operating performance, growth rates and other factors. Estimates of undiscounted cash flows may differ from actual cash flows due to factors such as technological changes, economic conditions, and changes in the Company’s business model or operating performance. If at the time of such evaluation the sum of expected undiscounted cash flows (excluding interest) is below the carrying value, an impairment loss is recognized, which is measured as the amount by which the carrying value exceeds the fair value of the asset as determined by market participant assumptions. Indefinite-lived intangible assets are also reviewed annually for potential impairment.

Goodwill and Indefinite-lived Trade Names

Goodwill is tested for impairment in value annually, as well as when events or circumstances indicate possible impairment in value. The Company performs an annual goodwill impairment test for each of its three reporting units (automotive, wireless audio, and analog/mixed signal) during the fourth quarter of each fiscal year. The Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of its reporting units is less than its carrying value. If, based on that assessment, the Company believes it is more likely than not that the fair value of its reporting units is less than its carrying value, a two-step goodwill impairment test is performed.

If the two-step goodwill impairment test is considered necessary, the Company considers both the market and income approaches in determining the estimated fair value of the reporting units, specifically the market multiple methodology and discounted cash flow methodology. The market multiple methodology involves the utilization of various revenue and cash flow measures at appropriate risk-adjusted multiples. Multiples are determined through an analysis of certain publicly traded companies that are selected on the basis of operational and economic similarity with the business operations. Provided these companies meet these criteria, they will be considered comparable from an investment standpoint even if the exact business operations and/or characteristics of the entities are not the same. Revenue and earnings before interest, taxes, depreciation and amortization (“EBITDA”) multiples are calculated for the comparable companies based on market data and published financial reports. A comparative analysis between the Company and the public companies deemed to be comparable form the basis for the selection of appropriate risk-adjusted multiples for the Company. The comparative analysis incorporates both quantitative and qualitative risk factors which relate to, among other things, the nature of the industry in which the Company and other comparable companies are engaged. In the discounted cash flow methodology, long-term projections prepared by the Company are utilized. The cash flows projected are analyzed on a “debt-free” basis (before cash payments to equity and interest bearing debt investors) in order to develop an enterprise value. A provision, based on these projections, for the value of the Company at the end of the forecast period, or terminal value are also made. The present value of the cash flows and the terminal value are determined using a risk-adjusted rate of return, or “discount rate.”

As of February 29, 2012, the Company had $5.7 million of indefinite-lived trademarks associated with its automotive reporting unit and $0.7 million of indefinite-lived trade names associated with its wireless audio reporting unit which were evaluated as part of the assessment of related goodwill.
 
 
The Company completed its most recent annual goodwill impairment test, which included the indefinite-lived trademarks and tradenames noted above, as of the last day of the Company’s fiscal year for each of its three reporting units. Upon completion of the fiscal 2012 assessment, it was determined that no impairment in value was identified.

During the fourth quarter of fiscal 2011 the Company lost its primary customer in its storage solutions business. As a result, the Company initiated a plan to reduce costs and investments in this business. In connection with this action, the Company incurred an impairment loss of $3.5 million, primarily for certain indefinite-lived purchased technologies acquired as part of this business.
 
Income Taxes
 
The Company accounts for income taxes under the asset and liability method which includes the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in our consolidated financial statements. Under this approach, deferred taxes are recorded for the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from differences between the financial statement and tax bases of our assets and liabilities, and are adjusted for changes in tax rates and tax laws when changes are enacted. The effects of future changes in income tax laws or rates are not anticipated.

The Company is subject to income taxes in the United States and numerous foreign jurisdictions. The calculation of our tax provision involves the application of complex tax laws and requires significant judgment and estimates. We evaluate the realizability of our deferred tax assets for each jurisdiction in which we operate at each reporting date, and we establish a valuation allowance when it is more likely than not that all or a portion of our deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income of the same character and in the same jurisdiction. We consider all available positive and negative evidence in making this assessment, including, but not limited to, the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies. In circumstances where there is sufficient negative evidence indicating that our deferred tax assets are not more likely than not realizable, we establish a valuation allowance.
 
The Company applies ASC 740, “Income Taxes” (“ASC 740”) in the accounting for uncertainty in income taxes recognized in its financial statements. ASC 740 requires that all tax positions be evaluated using a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Differences between tax positions taken in a tax return and amounts recognized in the financial statements are recorded as adjustments to income taxes payable or receivable, or adjustments to deferred taxes, or both.  The Company believes that its accruals for uncertain tax positions are adequate for all open audit years based on its assessment of many factors including past experience and interpretation of tax law.  To the extent that new information becomes available which causes the Company to change its judgment about the adequacy of its accruals for uncertain tax positions, such changes will impact income tax expense in the period such determination is made.  Our policy is to include interest and penalties related to unrecognized income tax benefits as a component of income tax expense.

Legal Contingencies
 
From time to time, the Company is subject to legal proceedings and claims, including claims of alleged infringement of patents and other intellectual property rights and other claims arising in the ordinary course of business. These contingencies require management to assess the likelihood and possible cost of adverse judgments or outcomes. Liabilities for legal contingencies are accrued when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. There can be no assurance that any third-party assertions against the Company will be resolved without costly litigation, in a manner that is not adverse to its financial position, results of operations or cash flows. In addition, the resolution of any future intellectual property litigation may subject the Company to royalty obligations, product redesigns or discontinuance of products, any of which could adversely impact future profitability.
 
Recent Accounting Standards
 
In September 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2011 - 08, “Testing Goodwill for Impairment” (“ASU 2011 - 08”), which permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform a two-step goodwill impairment test.  The updated guidance is effective for annual impairment tests performed for SMSC beginning in Fiscal 2013 with early adoption permitted.  The Company has elected to early adopt ASU 2011 - 08 in connection with its fiscal 2012 impairment analysis. The adoption of this guidance had no impact on our consolidated financial statements.
 
In June 2011, the FASB issued Accounting Standards Update 2011 - 05, “Presentation of Comprehensive Income” (“ASU 2011 - 05”), which provides guidance regarding the presentation of comprehensive income. The new standard requires the presentation of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2011-12, “ Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (“ASU 2011-12”), which defers requirements regarding reclassifications of items out of comprehensive income on the face of the income statement while retaining other requirements of ASU 2011-05. The updated guidance in ASU 2011 – 05 and ASU 2011 – 12 is effective for SMSC beginning in the first quarter of fiscal year 2013.  Management believes that the adoption of this guidance will not have a material impact on our consolidated financial statements.
 
 
In May 2011, the FASB issued Accounting Standards Update 2011 - 04, “Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRS” (“ASU 2011 - 04”), which provides additional guidance on fair value measurements that clarifies the application of existing guidance and disclosure requirements, changes certain fair value measurement principles and requires additional disclosures about fair value measurements. The updated guidance is effective on a prospective basis for SMSC beginning in the first quarter of fiscal year 2013. Management believes that the adoption of this guidance will not have a material impact on our consolidated financial statements.
 
In December 2010, the FASB issued Accounting Standards Update 2010 - 29, “Disclosure of Supplementary Pro Forma Information for Business Combinations” (“ASU 2010 - 29”), which specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments in this update also expand the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The new disclosures required by ASU 2010 – 29 were adopted by SMSC beginning in the first quarter of fiscal 2012. The adoption of ASU 2010 - 29 did not have a material effect on our consolidated financial statements.
 
RESULTS OF OPERATIONS

Business Outlook

Our future results of operations and other matters comprising the subject of forward-looking statements contained in this Form 10-K, included within this MD&A, involve a number of risks and uncertainties — in particular, current economic uncertainty, as well as future economic conditions; our goals and strategies; new product introductions; plans to cultivate new businesses; divestitures, acquisitions or investments; revenue; pricing; gross margin and costs; capital spending; depreciation; R&D expense levels; selling, general and administrative expense levels; potential impairment of investments; our effective tax rate; pending legal proceedings; and other operating parameters. In addition to the various important factors discussed above, a number of other important factors could cause actual results to differ materially from our expectations. See the risks described in Part I — Item 1.A. — Risk Factors.
 
The Company achieved record revenue levels in fiscal 2012 of $412.1 million and saw strength in the automotive and consumer electronics end markets. For fiscal 2013, we expect that the PC and industrial market will improve modestly, with stronger growth in the automotive and consumer electronics end markets. Design win activity remains healthy.
 
Fiscal Year Ended February 29, 2012 Compared to Fiscal Year Ended February 28, 2011

Overview
 
The Company’s stock compensation expense is sensitive to changes in the common stock market price.  While all of the Company’s stock-based compensation instruments are affected by market price changes, the Company’s Stock Appreciation Rights (“SARs”) have the most significant impact on the results of operations because as liability-based awards they are marked to market each reporting period with the resulting change in value charged to operating income. The following table summarizes the stock-based compensation expense for stock options, restricted stock awards, restricted stock units, employee stock purchase plan shares and stock appreciation rights included in results of operations (in thousands):
 
   
Fiscal
   
Fiscal
 
   
2012
   
2011
 
Costs of goods sold
  $ 662     $ 2,710  
Research and development
    2,487       6,919  
Selling, general and administrative
    5,055       14,574  
Stock-based compensation before income tax benefit
  $ 8,204     $ 24,203  

The decrease in stock-based compensation is mainly driven by the Company’s SARs due to the fluctuations in the Company’s common stock market price during the fiscal 2012 as compared to fiscal 2011. SARs expense decreased $18.6 million in fiscal 2012, as compared to fiscal 2011. The amounts above exclude $1.8 million and $2.0 million of expense related to the 401K match issued in stock in fiscal 2012 and 2011, respectively.
 
 
Sales and revenues, gross profit on sales and revenue, operating income, and net income for fiscal 2012 and 2011 were as follows (in thousands):

   
2012
   
2011
   
Inc./Dec. $
   
Inc./Dec. %
 
Sales and revenues
  $ 412,104     $ 409,479     $ 2,625       0.6 %
Gross profit
  $ 215,658     $ 214,894     $ 764       0.4 %
Gross profit as percentage of sales and revenues
    52.3 %     52.5 %                
Operating income
  $ 27,994     $ 18,647     $ 9,347       50.1 %
Operating income as percentage of sales and revenues
    6.8 %     4.6 %                
Net income
  $ 10,662     $ 10,627     $ 35       0.3 %

The Company achieved record sales and revenue levels in fiscal 2012.  Sales and revenues increased primarily due to incremental sales and revenues from the wireless audio (including revenues associated with BridgeCo) and automotive products, partially offset by lower revenue from PC and industrial products.

Gross profit increased slightly mainly due to increased sales and revenues and lower stock-based compensation expense partially offset by increased amortization expense from acquired intangibles. Operating income mainly benefited from reduced stock-based compensation expense partially offset by increased R&D compensation costs related to the BridgeCo acquisition. Fiscal 2012 operating income includes charges related to a fourth quarter restructuring action partially offset by income related to the revaluation of contingent consideration. Fiscal 2011 operating income includes an acquisition termination fee gain, income related to the revaluation of contingent consideration of certain acquisitions mainly offset by impairments related to Symwave and other restructuring charges.

Net income remained relatively consistent as compared to the prior fiscal year period. The increase in operating income noted above was partially offset by an increase in the effective income tax rate.

Sales and Revenues
 
Sales and revenues by end market for fiscal 2012 and 2011 were as follows (in thousands):
 
   
2012
   
2011
   
Inc./Dec. $
   
Inc./Dec. %
 
PCs
  $ 131,132     $ 151,595     $ (20,463 )     -13.5 %
Consumer Electronics
    129,451       110,265       19,186       17.4 %
Automotive
    84,597       74,803       9,794       13.1 %
Industrial
    66,924       72,816       (5,892 )     -8.1 %
Total
  $ 412,104     $ 409,479     $ 2,625       0.6 %

Sales and revenues by reporting unit for fiscal 2012 and 2011 were as follows (in thousands):

   
2012
   
2011
   
Inc./Dec. $
   
Inc./Dec. %
 
Analog / Mixed Signal
  $ 286,934     $ 326,428     $ (39,494 )     -12.1 %
Automotive
    83,376       73,164       10,212       14.0 %
Wireless Audio
    41,794       9,887       31,907       322.7 %
Total
  $ 412,104     $ 409,479     $ 2,625       0.6 %

The PCs and industrial end markets continue to be impacted by negative global macroeconomic conditions resulting in reduced sales in the Analog/Mixed Signal reporting unit. Consumer Electronics benefitted from the acquisition of BridgeCo which contributed $28.1 million to the year over year improvement in Wireless Audio.  Automotive sales and revenues increased due to continued strong demand from automotive based customers.
 
 
Gross Profit, Operating Expenses, and Income from Operations

Gross profit, operating expenses and income from operations were as follows (in thousands):
 
For the Fiscal Years Ended February 29 and 28,
 
2012
   
2011
   
Inc./Dec. $
   
Inc./Dec. %
 
Gross profit on sales and revenues
  $ 215,658     $ 214,894     $ 764       0.4 %
Gross profit as percentage of sales and revenues
    52.3 %     52.5 %                
Operating expenses:
                               
Research and development
  $ 100,350     $ 96,370     $ 3,980       4.1 %
Selling, general and administrative
    86,706       100,661       (13,955 )     -13.9 %
Acquisition termination fee gain
    -       (7,700 )     7,700       N/M *
Restructuring charges
    1,973       4,703       (2,730 )     -58.0 %
Impairment loss on equity investment (Symwave)
    -       3,208       (3,208 )     N/M *
Gain on equity investment (Canesta)
    -       (320 )     320       N/M *
Revaluation of contingent acquistion liabilities
    (1,365 )     (4,206 )     2,841       -67.5 %
Impairment loss on Symwave intangible assets (Symwave)
    -       3,531       (3,531 )     N/M *
                                 
Income from operations
  $ 27,994     $ 18,647     $ 9,347       50.1 %
*N/M – Not meaningful
                               
 
Gross Profit
 
Gross profit and gross profit as a percentage of sales and revenues was relatively consistent as compared to the prior fiscal year period. Lower stock-based compensation costs of $2.0 million, was partially offset by higher intangible amortization related to acquisitions of $1.6 million.

Research and Development

The increase in R&D costs was primarily due to increased system design tool depreciation of $3.2 million, compensation costs of $2.9 million related to the BridgeCo acquisition and consulting expenses of $1.7 million. These increases were partially offset by reduced stock-based compensation charges of $4.4 million.

Selling, General and Administrative (“SG&A”)
 
SG&A expenses decreased mainly due to reduced stock-based compensation expense of $9.5 million and declines in accounting and legal fees of $3.1 million. In fiscal 2011, the Company incurred increased accounting and legal fees of as part of the effort to acquire Conexant Systems, Inc. (“Conexant”).

Acquisition Termination Fee Gain

On January 9, 2011, the Company and Conexant entered into an Agreement and Plan of Merger (“Merger Agreement”). The agreement was terminated by Conexant pursuant to the terms and conditions specified in the Merger Agreement on February 23, 2011.  As a result, Conexant paid SMSC a termination fee of $7.7 million in fiscal 2011.

Restructuring Charges

Restructuring charges for fiscal 2012 and 2011 were as follows (in thousands):

For the fiscal year ended February 29 and 28,
 
2012
   
2011
 
             
Employee Severance and Benefits Charges
  $ 1,900     $ 3,659  
Asset Impairment Charges
    73       1,044  
    $ 1,973     $ 4,703  

During the fourth quarter of fiscal 2012 the Company initiated a plan to reduce certain operating expenses. As a result approximately 60 positions worldwide were eliminated as part of the plan to reduce operating expenses by approximately $6 to $7 million on an annual basis. Costs incurred as result of this action resulted in charges for employee severance and benefits of $1.5 million. The Company expects these cost reduction activities and cash payments to be completed during the first quarter of fiscal 2013.
 
 
During the second quarter of fiscal 2012 the Company reorganized certain engineering groups resulting in severance charges of $0.4 million. The Company expects the remaining cash payments on these obligations to be completed during the first quarter of fiscal 2013.

During the fourth quarter of fiscal 2011 the Company initiated a plan to reduce costs and investments in certain businesses.  As a result, approximately 80 positions worldwide, including approximately 50 positions at its subsidiary in Shenzhen China, were eliminated as part of the plan to substantially reduce investment in storage solutions acquired as part of the Symwave acquisition.  The remaining positions eliminated consisted of certain positions in its subsidiary in Canada as part of its plan to converge the wireless audio products roadmap from the Kleer and STS acquisitions and to rationalize worldwide resources working on wireless audio products, and certain engineering and administrative positions. A charge for employee severance and benefits of $3.5 million was incurred in fiscal 2011.

In the second quarter of fiscal 2011, the Company initiated a restructuring plan for 9 employees. A charge of $0.3 million was incurred in fiscal 2011 for severance and termination benefits relating to this restructuring plan.

During fiscal 2010, the Company initiated restructuring plans to reduce its workforce by 64 employees in connection with the relocation of certain of its test floor activities from Hauppauge, New York to third party offshore facilities (Sigurd Microelectronics Corporation) in Taiwan and another 5 employees in the fourth quarter. A charge of $0.8 million was incurred in fiscal 2011 for severance and termination relating to this restructuring plan.

Impairment Loss on Equity Investment in Symwave

On November 12, 2010 SMSC completed the acquisition of Symwave, Inc. (“Symwave”).  SMSC had invested $5.2 million (“Initial Investment”) in Symwave shares in fiscal 2010. At acquisition, the Initial Investment was reduced to its fair value of $2.0 million and an impairment loss of $3.2 million was recorded within income from operations in accordance with U.S. GAAP.

Gain on Equity Investment in Canesta

During fiscal 2010, SMSC invested $2.0 million in Canesta. Canesta entered into an Asset Purchase Agreement with Microsoft, pursuant to which Microsoft acquired substantially all of the assets of Canesta. On November 30, 2010, SMSC received $2.2 million in cash from Canesta and another $0.1 million on January 27, 2011 pursuant to its Asset Purchase Agreement with Microsoft (approximately $0.7 million in additional distributions will be held in escrow for 12 months or until all of the obligations of Canesta have been satisfied). As a result, the Company recorded a gain of $0.3 million.

Revaluation of Contingent Acquisition Liabilities

The Company recorded liabilities for contingent consideration as part of the purchase price for the acquisitions of BridgeCo, Symwave, STS, Kleer and K2L. The payment of contingent consideration is based upon the achievement of certain financial results over specified time periods post-acquisition. The Company performs a quarterly revaluation of contingent consideration and records any changes in estimated payments and accretion expense as a component of operating income. A $1.5 million net gain was recorded in fiscal 2012 due to reduced forecasted financial results related to BridgeCo.

Due to reductions in estimated future operating results of Symwave, Kleer and STS, a gain of $4.2 million was recorded in fiscal 2011. The revaluation of the Symwave contingent consideration accounted for $3.1 million of this gain, partially offset by an increase in K2L contingent consideration of $0.9 million.

Impairment Loss on Symwave Intangible Assets

During the fourth quarter of fiscal 2011 the Company initiated a plan to reduce costs and investments in the storage solutions business acquired as part of the Symwave acquisition. In connection with this action, the Company incurred an impairment loss of $3.5 million, primarily for certain indefinite-lived technology intangibles acquired.
 
 
Interest and Other Income (Expense)

Interest and other income (expense) for fiscal 2012 and 2011 were as follows (in thousands):

For the Fiscal Years Ended February 29 and 28,
 
2012
   
2011
   
Inc./Dec. $
   
Inc./Dec. %
 
Interest income
  $ 301     $ 659     $ (358 )     -54.3 %
Interest expense
    (155 )     (153 )     (2 )     1.3 %
Other income (expense), net
    86       (248 )     334       -134.7 %
    $ 232     $ 258     $ (26 )     -10.1 %

The decrease in interest income is primarily the result of a decrease in the Company’s overall investment in auction rate securities, as the Company continues to liquidate its positions as opportunities arise in response to market conditions and an overall reduction in interest rates. The Company is currently investing in money market funds, and certain high quality fixed income securities with an AA rating or better and ample market liquidity.
 
Other income (expense), net primarily consists of unrealized foreign exchange gains and losses on U.S. dollar denominated assets and liabilities held by the Company’s foreign subsidiaries.
 
Provision for Income Taxes
 
The following table sets forth our income tax provision and net income for fiscal years 2012 and 2011 (in thousands):

For the Fiscal Years Ended February 29 and 28,
 
2012
   
2011
   
Inc./Dec. $
   
Inc./Dec. %
 
                         
Income before income taxes
  $ 28,226     $ 18,905     $ 9,321       49.3 %
                                 
Provision for income taxes
  $ 17,564     $ 8,278     $ 9,286       112.2 %
Provision for income taxes as percentage of income before income taxes
    62.2 %     43.8 %     18.4 %     42.0 %
Net income
  $ 10,662     $ 10,627     $ 35       0.3 %

For fiscal 2012 and fiscal 2011, our overall effective tax rate was higher than the U.S. federal statutory rate of 35% primarily due to the mix of income and losses by jurisdiction.  In addition, the Company maintains valuation allowances and did not record significant income tax benefit for losses incurred by certain foreign subsidiaries, however it recorded a significant income tax expense for income earned in the United States and an increase in the liability for unrecognized tax benefits for fiscal 2012.  For fiscal 2012 and fiscal 2011, the impact of higher rates are partially offset primarily by credits generated for research and experimentation activities, while a tax benefit for a change in state tax rates was recorded for fiscal 2012.
 
Fiscal Year Ended February 28, 2011 Compared to Fiscal Year Ended February 28, 2010

Overview
 
The Company’s stock-based compensation expense is sensitive to changes in the common stock market price.  While all of the Company’s stock-based compensation instruments are affected by market price changes, the Company’s SARs have the most significant impact on the results of operations because as liability-based awards they are marked to market each reporting period with the resulting change in value charged to operating income.
 
The following table summarizes the stock-based compensation expense for stock options, restricted stock awards, restricted stock units, employee stock purchase plan shares and stock appreciation rights included in results of operations (in thousands):
 
   
Fiscal
   
Fiscal
 
   
2011
   
2010
 
Costs of goods sold
  $ 2,710     $ 1,629  
Research and development
    6,919       4,571  
Selling, general and administrative
    14,574       9,770  
Stock-based compensation before income tax benefit
  $ 24,203     $ 15,970  

The amounts above exclude $2.0 million and $1.9 million of expense related to the 401K match issued in stock in fiscal 2011 and 2010, respectively.
 
 
Sales and revenues, gross profit on sales and revenue, income (loss) from operations, and net income (loss) for fiscal 2011 and 2010 were as follows (in thousands):

   
2011
   
2010
   
Inc./Dec. $
   
Inc./Dec. %
 
Sales and revenues
  $ 409,479     $ 307,778     $ 101,701       33.0 %
Gross profit
  $ 214,894     $ 152,906     $ 61,988       40.5 %
Gross profit as percentage of sales and revenues
    52.5 %     49.7 %                
Operating income (loss)
  $ 18,647     $ (13,987 )   $ 32,634       N/M *
Operating income (loss) as percentage of sales and revenues
    4.6 %     -4.5 %                
Net income (loss)
  $ 10,627     $ (7,978 )   $ 18,605       N/M *
*N/M – Not meaningful
                               

The increase in sales and revenues was primarily a result of overall improvements in global demand for goods that incorporate the Company’s products resulted in gains across all end markets. The Company acquired Symwave and STS in fiscal 2011 contributing to the sales and revenue improvement.  Symwave is a fabless supplier of high-performance analog/mixed-signal connectivity solutions. STS is a fabless designer of plug-and-play wireless solutions for consumer audio streaming applications providing a robust, low latency low power digital audio baseband processor and integrated module solutions which are highly complementary to SMSC's Kleer wireless audio products.

Gross profit and operating income benefited from the rise in sales and revenue by leveraging production overhead and fixed costs; this was partially offset by stock compensation expense increases. Restructuring actions taken in the first quarter of fiscal 2010 to lower supply chain costs also contributed to the gross profit improvement. Operating income also improved due to an acquisition termination fee gain and income related to the revaluation of contingent consideration of certain acquisitions. In addition, the Company announced restructuring actions in the fourth quarter of fiscal 2011 to reduce its investment in storage solutions and converge wireless technology roadmaps associated with the STS and Kleer acquisitions.  These actions resulted in impairments and write-downs of certain long-lived assets acquired in the Symwave acquisition as well as severance costs.
 
Net income increased primarily due to the rise in operating income as referred to previously.

Sales and Revenues
 
Sales and revenues by end market for fiscal 2011 and 2010 were as follows (in thousands):

   
2011
   
2010
   
Inc./Dec. $
   
Inc./Dec. %
 
PCs
  $ 151,595     $ 124,971     $ 26,624       21.3 %
Consumer Electronics
    110,265       80,767       29,498       36.5 %
Industrial
    72,816       51,749       21,067       40.7 %
Automotive
    74,803       50,291       24,512       48.7 %
Total
  $ 409,479     $ 307,778     $ 101,701       33.0 %

Sales and revenues by reporting unit for fiscal 2011 and 2010 were as follows (in thousands):

   
2011
   
2010
   
Inc./Dec. $
   
Inc./Dec. %
 
Analog / Mixed Signal
  $ 326,428     $ 257,820     $ 68,608       26.6 %
Automotive
    73,164       49,886       23,278       46.7 %
Wireless Audio
    9,887       72       9,815       N/M *
Total
  $ 409,479     $ 307,778     $ 101,701       33.0 %
* N/M - Not meaningful
                               

Sales and revenues increased primarily due to improvements in global demand for goods that incorporate the Company’s products, in each of our end markets (PC, Automotive, Consumer and Industrial). In addition, PC, Industrial and Wireless Audio product sales increased due to the acquisitions of Kleer and STS. The acquisition of Symwave on November 12, 2010 contributed $7.4 million to the year over year improvement in Consumer Electronics and Analog / Mixed Signal.
 

Gross Profit, Operating Expenses and Income (loss) from Operations

Gross profit, operating expenses and income (loss) from operations for fiscal 2011 and 2010 were as follows (in thousands) :

For the Fiscal Years Ended February 28,
 
2011
   
2010
   
Inc./Dec. $
   
Inc./Dec. %
 
Gross profit on sales and revenues
  $ 214,894     $ 152,906     $ 61,988       40.5 %
Gross profit as percentage of sales and revenues
    52.5 %     49.7 %                
Operating expenses:
                               
Research and development
  $ 96,370     $ 77,702     $ 18,668       24.0 %
Selling, general and administrative
    100,661       85,049       15,612       18.4 %
Acquisition termination fee gain
    (7,700 )     -       (7,700 )     N/M *
Restructuring charges
    4,703       2,123       2,580       N/M *
Impairment loss on equity investment (Symwave)
    3,208       -       3,208       N/M *
Gain on equity investment (Canesta)
    (320 )     -       (320 )     N/M *
Revaluation of contingent acquistion liabilities
    (4,206 )     -       (4,206 )     N/M *
Impairment loss on Symwave intangible assets (Symwave)
    3,531       -       3,531       N/M *
Settlement charge
    -       2,019       (2,019 )     N/M *
                                 
Income (loss) from operations
  $ 18,647     $ (13,987 )   $ 32,634       N/M *
*N/M – Not meaningful
                               

The increase in gross profit as a percentage of sales and revenues was primarily due to increased sales and production levels, which reduced unabsorbed manufacturing overhead costs compared to the prior year, significant reductions in supply chain costs and structural changes in the Company’s supply and logistics chain, most notably the outsourcing of a significant portion of product test activities implemented in the third quarter of fiscal 2010. The impact of these reduced costs in the current fiscal year was partially offset by the write-off of $2.2 million in inventory related to the Company’s storage solutions business, as well as the increase of $1.1 million in stock compensation charges mainly associated with the SARs.

Research and Development Expenses
 
The increase in R&D costs was primarily due to the increase in engineering headcount and related compensation of $8.9 million associated with the acquisitions of Tallika, K2L and Kleer in the prior fiscal year and STS and Symwave in the current fiscal year. Other increases include depreciation expense of $2.4 million primarily due to the purchase of system design tools and $2.3 million relating to stock-based compensation charges associated with SARs, as mentioned previously.

Selling, General and Administrative Expenses
 
The increase in SG&A expenses is mainly due to an increase of $5.4 million in accounting and legal fees as part of the effort to acquire Conexant Systems, Inc. (“Conexant”), including financial advisor termination fees, $4.8 million in stock-based compensation charges associated with SARs, as mentioned previously, and an increase of $1.5 million in depreciation and amortization.

Acquisition Termination Fee Gain

On January 9, 2011, the Company and  Conexant entered into an Agreement and Plan of Merger (“Merger Agreement”). The agreement was terminated by Conexant pursuant to the terms and conditions specified in the Merger Agreement on February 23, 2011.  As a result, Conexant paid SMSC a termination fee of $7.7 million.

Restructuring Charges
 
Restructuring charges for fiscal 2011 and 2010 were as follows (in thousands):

For the fiscal year ended February 29 and 28,
 
2011
   
2010
 
             
Employee Severance and Benefits Charges
  $ 3,659     $ 1,715  
Asset Impairment Charges
    1,044       408  
    $ 4,703     $ 2,123  

During the fourth quarter of fiscal 2011 the Company initiated a plan to reduce costs and investments in certain businesses.  As a result, approximately 80 positions worldwide, including approximately 50 positions at its subsidiary in Shenzhen China, were eliminated as part of the plan to substantially reduce investment in storage solutions acquired as part of the Symwave acquisition.  The remaining positions eliminated consisted of certain positions in its subsidiary in Canada as part of its plan to converge the wireless audio products roadmap from the Kleer and STS acquisitions and to rationalize worldwide resources working on wireless audio products, and certain engineering and administrative positions. A charge for employee severance and benefits of $3.5 million was incurred in fiscal 2011.
 
 
In the second quarter of fiscal 2011, the Company initiated a restructuring plan for 9 employees. A charge of $0.3 million was incurred in fiscal 2011 for severance and termination benefits relating to this restructuring plan.
 
During fiscal 2010, the Company initiated restructuring plans to reduce its workforce by 64 employees in connection with the relocation of certain of its test floor activities from Hauppauge, New York to third party offshore facilities (Sigurd Microelectronics Corporation) in Taiwan and another 5 employees in the fourth quarter. A charge of $0.8 million was incurred in fiscal 2011 for severance and termination relating to this restructuring plan.

Impairment Loss on Equity Investment in Symwave
 
On November 12, 2010 SMSC completed the acquisition of Symwave, Inc. (“Symwave”).  SMSC had invested $5.2 million (“Initial Investment”) in Symwave shares in fiscal 2010. At acquisition, the Initial Investment was reduced to its fair value of $2.0 million and an impairment loss of $3.2 million was recorded within income from operations in accordance with U.S. GAAP.
 
Gain on Equity Investment in Canesta
 
During fiscal 2010, SMSC invested $2.0 in Canesta. Canesta entered into an Asset Purchase Agreement with Microsoft, pursuant to which Microsoft acquired substantially all of the assets of Canesta. On November 30, 2010, SMSC received $2.2 million in cash from Canesta and another $0.1 million on January 27, 2011 pursuant to its Asset Purchase Agreement with Microsoft (approximately $0.7 million in additional distributions will be held in escrow for 12 months or until all of the obligations of Canesta have been satisfied). As a result, the Company recorded a gain of $0.3 million.
 
Revaluation of Contingent Acquisition Liabilities
 
The Company recorded a liability for contingent consideration as part of the purchase price for the acquisitions of Symwave, STS, Kleer and K2L. The Company performs a quarterly revaluation of contingent consideration and records the change as a component of operating income. Due to reductions in estimated future operating results of Symwave, Kleer and STS, a gain of $4.2 million was recorded in fiscal 2011. The Company expects to make no contingent consideration payments related to these acquisitions. The revaluation of the Symwave contingent consideration accounted for $3.1 million of this gain, partially offset by an increase in K2L contingent consideration of $0.9 million.
 
Impairment Loss on Symwave Intangible Assets
 
During the fourth quarter of fiscal 2011 the Company initiated a plan to reduce costs and investments in the storage solutions business acquired as part of the Symwave acquisition. In connection with this action, the Company incurred an impairment loss of $3.5 million, primarily for certain indefinite-lived technology intangibles acquired.
 
Settlement Charge
 
A charge of $2.0 million in settlement of the OPTi, Inc. patent infringement lawsuit against the Company was recognized in fiscal 2010.
 
Interest and Other (Expense) Income
 
Interest and other income (expense) for fiscal 2011 and 2010 were as follows (in thousands):

For the Fiscal Years Ended February 28,
 
2011
   
2010
   
Inc./Dec. $
   
Inc./Dec. %
 
Interest income
  $ 659     $ 981     $ (322 )     -32.8 %
Interest expense
    (153 )     (163 )     10       -6.1 %
Other expense, net
    (248 )     (514 )     266       -51.8 %
    $ 258     $ 304     $ (46 )     -15.1 %

The decrease in interest income is primarily the result of a decrease in the Company’s overall investment in auction rate securities, as the Company continues to liquidate its positions as opportunities arise in response to market conditions and an overall reduction in interest rates. The Company is currently investing in money market funds, and certain high quality fixed income securities with an AA rating or better and ample market liquidity.
 
Other expenses, net primarily consist of unrealized foreign exchange gains and losses on U.S. dollar denominated assets and liabilities held by the Company’s foreign subsidiaries.

Provision for Income Taxes
 
Provision for (benefit from) income taxes and net income (loss) for fiscal 2011 and 2010 were as follows (in thousands):

For the Fiscal Years Ended February 28,
 
2011
   
2010
   
Inc./Dec. $
 
                   
Income (loss) before income taxes
  $ 18,905     $ (13,683 )   $ 32,588  
                         
Provision for (benefit from) income taxes
  $ 8,278     $ (5,705 )   $ 13,983  
Provision for (benefit from) income taxes as percentage of income (loss) before income taxes
    43.8 %     41.7 %     2.1 %
Net income (loss)
  $ 10,627     $ (7,978 )   $ 18,605  

The Company’s effective income tax rate reflects statutory federal, state and foreign tax rates, the impact of certain permanent differences between the book and tax treatment of certain expenses, and the impact of tax-exempt income and various income tax credits.
 
The provision for income taxes included the impact of $2.3 million from income tax credits and incentives (including $0.2 million relating to U.S. federal research and development credits attributable to the prior fiscal year), $0.2 million from tax exempt income, a $1.4 million incremental tax from differences between foreign and U.S. income tax rates, $4.1 million of foreign losses not benefited in the provision, and a reversal of unrecognized tax benefits of $2.1 million.
 
The benefit from income taxes for fiscal 2010 included the impact of $1.3 million from income tax credits and incentives, $0.2 million from tax exempt income, a $0.9 million incremental tax from differences between foreign and U.S. income tax rates, and a reversal of unrecognized tax benefits of $1.0 million.

LIQUIDITY & CAPITAL RESOURCES
 
The Company currently finances its operations through a combination of existing working capital resources and cash generated by operations. The Company had no bank debt during fiscal 2012, 2011 or 2010. The Company may consider utilizing cash to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. From time to time, in the ordinary course of business, the Company may evaluate potential acquisitions of or investments in such businesses, products or technologies owned by third parties.

The Company expects that its cash, cash equivalents and cash flows from operations will be sufficient to finance the Company’s operating and capital requirements through the end of fiscal 2013 and for the foreseeable future.

Cash Flow

For the Fiscal Years Ended February 29 and 28,
 
2012
   
2011
   
2010
 
 
 
(in thousands)
 
Cash flows from operating activities:
 
 
   
 
   
 
 
Net income (loss)
  $ 10,662     $ 10,627     $ (7,978 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
    50,525       54,700       37,460  
Changes in operating assets and liabilities, net of effects of business acquisitions:
    (135 )     (20,352 )     10,471  
                         
Net cash provided by operating activities
    61,052       44,975       39,953  
Cash flows from investing activities: